Economic and Financial Market Update: Inflation - things that make you go 'hmmm'

Summary:

• Inflation was a lot higher than expected in Q1;
• It is possible that Q1 was the peak quarter for inflation;
• But the risks are that inflation will remain above the RBA’s 2-3% inflation target into next year;
• Strong economic growth and too high inflation means interest rate hikes are imminent;
• I expect the cash rate to be at least 1.25% by year-end.

Back in 1990 there was a hit song, “Things that make you go ‘hmmm” by C+C Music Factory. Personally it wasn’t one of my favourites. But the song came to mind when the Q1 inflation numbers were released. Analysts expected a big number, but not that big. According to the ABS the CPI increased by 2.1% in the March quarter. You have to go back to the GST to see a bigger quarterly rise. And before that it was September 1989 when Richard Marx was topping the charts. 

The price rises were broad. The so-called ‘trimmed mean’ (a mathematical approach to eliminating the most volatile movements) used as a measure of ‘underlying’ inflation rose by a big 1.4% in the quarter. Over half the items in the CPI basket have risen by over 3% over the past year. Goods inflation has been stronger than services reflecting stronger demand. Goods prices have also been more heavily impacted by supply-chain problems and rising input costs. The end of government incentives meant rising housing costs. Government incentives (such as restaurant vouchers) helped hold down the price of a meal out.

Strongly rising prices is no surprise for households and firms. In April consumer inflation expectations are at their highest level in over ten years. Business price expectations (in the retail sector) were at their highest ever level in the March quarter.

To read my full update, click here.

We live in interesting times.

Regards,

Peter Munckton - Chief Economist