Let’s rewind to the start of 2022. Everyone saw inflation rising and knew interest rate rises were coming. Domestically, we had the same opinion as just about every other investment professional – interest rate hikes in Australia will bite harder and faster on the consumer because of the prevalence of floating rate mortgages. The RBA subsequently didn’t raise rates as high as the US, but given the prevailing narrative, shouldn’t our inflation have come under control quicker? While most of the world is seeing inflation return back to normal, it seems unusually sticky here. In fact, many professional economists and money managers argue that the RBA should be raising rates further to deal with inflation.
In addition, the US has been running a fiscal deficit, injecting money back into the system to help the consumer – in fact, a 7%-7.5% fiscal deficit is recession-type levels of spending. This may be why they are likely to achieve the unicorn scenario of a ‘soft landing’ – when the economy slows just enough to pull everything into line, without going into recession. But Australia is running a fiscal surplus, it’s not handing out cheques and isn’t building infrastructure projects to the same magnitude as the US. So why would our inflation be stickier?
Let’s look at what the drivers of inflation are here compared to the US. First off, something very strange is occurring in Australia’s inflation – tradeable inflation (that is from tradeable goods coming from overseas) has fallen, but non-tradeable – the goods that can’t be traded (think fresh produce, bread, haircuts) – are not coming down. Yet it is tradable inflation that arguably the RBA has some control over, they can’t do much about non-tradable inflation. Interest rates hurting the consumers ability to spend should bring down the non-tradable component because of the cost squeeze on the consumer due to higher interest rates – but it’s not:
Source: Australian Bureau of Statistics
Next is the makeup of inflation. In the US we can see the common trend of food, goods and energy coming down, but services remaining sticky (which should be no surprise, it’s been talked about constantly when referring to inflation):
Source: Bloomberg
When we look at Australia’s services inflation we see the same this, with goods dropping the most, but services also starting to fall:
Source: Bloomberg
So why is our inflation so sticky if our services inflation is coming down but it isn’t in the US? The answer lays in the 3rd item – rental inflation. Australia has had an immigration boom, and without that immigration, we would be in recession right now (on a GDP per capita basis, ex-migration, we’ve been in recession for 6 months). The US HAD a rental inflation problem, but this seems to be moderating – and makes up an enormous part of the total inflation figure. When compared to Australia, we can see the problem:
Source: Bloomberg
So without immigration, we’d be in a recession, but that puts upward pressure on rents, and that has stalled the decline in inflation here. When demand outstrips supply, you get price rises. Simple economics 101.
Alongside rents having a stickier component, which Australia and the US both share, Australia is being held up by travel & accommodation costs (domestic and international), medical services inflation, education and insurance costs. The recent weakness in consumption should slow these price pressures, but sectors closer to government help may take longer to slow. Despite all this, a glimmer of hope is that wages growth never reached the levels of the US or the UK, hence shouldn’t cause a lot of issues going forward.
Conclusion
For some reason, non-tradeable inflation, which should be the most susceptible to rate rises, are staying much higher than tradeable inflation. This is likely due to immigration, without which, we’d be in a recession. The federal government hasn’t spent like crazy to keep the economy moving at a fast pace – it has let immigration keep its head above water and out of a recession for now. But it is still a conundrum – higher interest rates should generally lower non-tradeable inflation and reduce rental demand as consumers can’t afford the rents being charged – but back to supply and demand, if you increase the demand without increasing the supply, you get this as a result. Australia’s inflation is remaining frustratingly sticky and has the RBA in a very tough spot. Raise rates, and we’ll likely go into recession. Don’t raise them and inflation may stay higher for longer. Not an enviable position to be in.
What is going on with Australian inflation?
Let’s rewind to the start of 2022. Everyone saw inflation rising and knew interest rate rises were coming. Domestically, we had the same opinion as just about every other investment professional – interest rate hikes in Australia will bite harder and faster on the consumer because of the prevalence of floating rate mortgages. The RBA subsequently didn’t raise rates as high as the US, but given the prevailing narrative, shouldn’t our inflation have come under control quicker? While most of the world is seeing inflation return back to normal, it seems unusually sticky here. In fact, many professional economists and money managers argue that the RBA should be raising rates further to deal with inflation.
In addition, the US has been running a fiscal deficit, injecting money back into the system to help the consumer – in fact, a 7%-7.5% fiscal deficit is recession-type levels of spending. This may be why they are likely to achieve the unicorn scenario of a ‘soft landing’ – when the economy slows just enough to pull everything into line, without going into recession. But Australia is running a fiscal surplus, it’s not handing out cheques and isn’t building infrastructure projects to the same magnitude as the US. So why would our inflation be stickier?
Let’s look at what the drivers of inflation are here compared to the US. First off, something very strange is occurring in Australia’s inflation – tradeable inflation (that is from tradeable goods coming from overseas) has fallen, but non-tradeable – the goods that can’t be traded (think fresh produce, bread, haircuts) – are not coming down. Yet it is tradable inflation that arguably the RBA has some control over, they can’t do much about non-tradable inflation. Interest rates hurting the consumers ability to spend should bring down the non-tradable component because of the cost squeeze on the consumer due to higher interest rates – but it’s not:
Source: Australian Bureau of Statistics
Next is the makeup of inflation. In the US we can see the common trend of food, goods and energy coming down, but services remaining sticky (which should be no surprise, it’s been talked about constantly when referring to inflation):
Source: Bloomberg
When we look at Australia’s services inflation we see the same this, with goods dropping the most, but services also starting to fall:
Source: Bloomberg
So why is our inflation so sticky if our services inflation is coming down but it isn’t in the US? The answer lays in the 3rd item – rental inflation. Australia has had an immigration boom, and without that immigration, we would be in recession right now (on a GDP per capita basis, ex-migration, we’ve been in recession for 6 months). The US HAD a rental inflation problem, but this seems to be moderating – and makes up an enormous part of the total inflation figure. When compared to Australia, we can see the problem:
Source: Bloomberg
So without immigration, we’d be in a recession, but that puts upward pressure on rents, and that has stalled the decline in inflation here. When demand outstrips supply, you get price rises. Simple economics 101.
Alongside rents having a stickier component, which Australia and the US both share, Australia is being held up by travel & accommodation costs (domestic and international), medical services inflation, education and insurance costs. The recent weakness in consumption should slow these price pressures, but sectors closer to government help may take longer to slow. Despite all this, a glimmer of hope is that wages growth never reached the levels of the US or the UK, hence shouldn’t cause a lot of issues going forward.
Conclusion
For some reason, non-tradeable inflation, which should be the most susceptible to rate rises, are staying much higher than tradeable inflation. This is likely due to immigration, without which, we’d be in a recession. The federal government hasn’t spent like crazy to keep the economy moving at a fast pace – it has let immigration keep its head above water and out of a recession for now. But it is still a conundrum – higher interest rates should generally lower non-tradeable inflation and reduce rental demand as consumers can’t afford the rents being charged – but back to supply and demand, if you increase the demand without increasing the supply, you get this as a result. Australia’s inflation is remaining frustratingly sticky and has the RBA in a very tough spot. Raise rates, and we’ll likely go into recession. Don’t raise them and inflation may stay higher for longer. Not an enviable position to be in.
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