The RBA is grappling with two key questions as it ponders rates.

Is inflation psychology shifting? This is one of two key questions the Reserve Bank (RBA) is asking itself ahead of some crucial decisions on rate movements this year.

Speaking at the Walkley Foundation lunch in Sydney on Tuesday, Governor Philip Lowe said the inflation psychology evidenced over the past decade appears to be shifting.

Businesses that once refused to hike prices for fear of customer loss are now readily jumping on the inflation bandwagon. Some businesses, he noted, have linked pay to inflation instead of delivering fixed increases on an annual basis.

“I’ve seen Westfarmers and Woolworths say we’re putting up prices. They’re no longer embarrassed about doing it,” Dr Lowe said, drawing distinct parallels between the behaviour of businesses 10 years ago and today.

“There is a shift going on but how pervasive is it?”

Parallel to its inflation psychology probe, the RBA is also peering into the labour market.

“The other psychology we’re looking at is in the labour market. At the moment workers are not getting bigger pay increases because of inflation. Will that be the case in six months’ time? I don’t know,” Dr Lowe conceded.

According to Dr Lowe, workers can expect a real wage cut of 1.5 per cent this year.

“Wages are maybe going up high two’s, let’s say three, and inflation is 4.5 per cent, so that’s a real wage cut of 1.5 per cent this year, so that will obviously affect people’s budgets.”

Dr Lowe does, however, hopes the inflation spike was a one-off, caused by current supply chain disruptions and soaring oil prices.

“The inflation rate at the moment is 3.5 per cent and will probably go up to 4.5 per cent, who knows, depending on what happens with oil prices,” Dr Lowe said.

The government has acknowledged the growing cost of living, announcing an upcoming cash splash in the budget.

Commenting on Australia’s stagnant real wage growth, Dr Lowe said he would “like to see some bigger increases”.

Earlier this month, Dr Lowe said it’s plausible that the cash rate will be increased later this year.

“We have scope to wait and assess incoming information and see how some of the uncertainties are resolved.

“We can be patient in a way that countries with substantially higher rates of inflation cannot.”

Headline inflation hit 3.5 per cent in the December quarter, above the central bank’s 2 to 3 per cent target band.

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