The fear of inflation has been spooking investors across the world since the beginning of 2021 as the global economic recovery gathered momentum. While the inflationary concerns have been more prevalent in the US economy amid a steeper-than-expected surge in inflation numbers, the price pressures continue to remain subdued in Australia.
In most parts of the world, investors have been encountering one of the biggest fears this year that inflation could run amok and impede the post-pandemic economic recovery. While such fears have substantially abated in recent days, rising fuel and property prices are indicating a further spike in inflation figures over the coming financial year.
Now, the question arises why investors are so concerned about inflation numbers? Well, it has to do with the detrimental impact higher prices leave on the companies’ profits, thereby stimulating a fall in their share prices.
At the same time, higher prices indicate that the economy is running too hot, which can prompt the central banks to tighten their monetary policies. That would mean higher interest rates and a shift away from other accommodative monetary policy settings like bond-buying programs. Consequently, the expectations of investors regarding bringing forward the interest rate hike tends to cause market volatility.
Before we move on to discuss the inflationary scenario in the Australian market, let us discuss how inflation expectations are unfolding in the US economy, which is a bellwether for the global economy:
Why are Inflation Expectations Declining in the US Market?
After surging to its highest level in about eight years in May 2021, the 10-year breakeven inflation rate seems to be taking a much-needed breather given its recent downtrend. The drop in inflation precursor contrasts the latest upbeat data from the US economy, relating to house prices and consumer sentiment.
With consumer confidence levels jumping to their highest level in 16 months in June 2021, consumers exhibited optimism over their own financial prospects and business conditions in the months ahead. Besides, US house prices accelerated at their fastest pace in over 30 years, with S&P CoreLogic Case-Shiller National Home Price Index rising by 14.6 per cent in the year ending April 2021.
Despite these price strains, strengthening labour market conditions amid a reopening economy seem to be successfully offsetting consumers’ concerns over inflationary pressures. Notably, the unemployment rate in the country is at its lowest level since the pandemic hit.
Besides, the remarks from the Federal Reserve (Fed) that inflationary pressures are transitory in nature, have helped soothe investors’ concerns over higher inflation in recent days. At a time when the US is observing its biggest jump in consumer price levels since August 2008, the central bank’s reassurance was much-needed to cool off hotter-than-expected inflation fears.
Meanwhile, the Fed’s strong belief of an eventual decline in price levels have strengthened views that an increase in interest rates is still some way off. Although a central bank’s official recently indicated an interest rate hike in 2023, the Fed remains focused on ensuring the US economy reaches full employment before adjusting its monetary policy.
While the US Fed foresees the rise in inflation to be transitory in nature, one cannot neglect that the central bank is currently falling behind the inflation curve. Given the scenario, Fitch Ratings expects US core CPI annual inflation to rise further in the coming months before falling back in 2022.
Where Does Australia Stand in Terms of Inflationary Pressures?
Although inflationary pressures are quite evident in the US economy, Australia appears to stand in a relatively better position where inflation levels remain subdued.
Inflation figures released by the Australian Bureau of Statistics (ABS) in April 2021 showed that consumer prices rose less than economists feared in March 2021 quarter. The Consumer Price Index grew by 0.6 per cent in the March quarter, while economists were tipping a much larger increase of 0.9 per cent in prices. This seems to have provided further room to the central bank to run the domestic economy harder.
At the same time, one cannot neglect the steam gradually building up in inflation expectations in Australia. As per the consumer inflation expectations data released by the Melbourne Institute, the expected inflation rate surged by 0.9 percentage points in June 2021 to 4.4 per cent. Meanwhile, the distribution of responses in the Melbourne Institute Survey revealed that about 64.3 per cent of respondents anticipate higher prices over the next 12 months.
As the Australian economy is rebounding much quickly than initially anticipated, higher-than-expected price increases come as no surprise. With rents back on the rise and the government’s HomeBuilder scheme now also closed for new applicants, it is yet to be seen if there will be some serious catch up in inflation numbers over the coming quarters.
While the Reserve Bank of Australia (RBA) sees decent prospects for growth and an eventual increase in prices and wages, inflation is not likely to be sustainably within its target range until at least 2024. The central bank’s forecasts reveal inflation below the mid-point of the target range through mid-2023. Given these projections, the central bank’s monetary policy is highly likely to remain stimulatory for some years to come.
Amidst the strong rebound in the Australian economy and termination of some government support policies introduced in the wake of COVID-19, an eventual upward pressure on price levels seems unavoidable over the long run. However, subdued growth in wages may limit any immediate pressures on price. It will be interesting to see how the central bank’s monetary policy support takes shape over time as the economic recovery intensifies further.