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Inflation is picking up and interest rates will soon follow

·4-min read
A close-up of Reserve Bank of Australia governor Philip Lowe. (Source: Getty)
RBA boss Philip Lowe has some tough decisions ahead. (Source: Getty)

It’s confirmed: inflation in Australia is picking up.

The September quarter consumer price index has risen 0.8 per cent, for an annual increase of 3.0 per cent.

In underlying terms, using the trimmed mean measure, inflation rose 0.7 per cent in the quarter for an annual rise of 2.1 per cent.

The quarterly rise in trimmed mean inflation rate is the highest since the December quarter 2013, while the annual increase is the highest since the December quarter 2015.

The inflation pick-up fits with the trends evident around the global economy, which show a clear and sharp upswing in inflation pressures.

Inflation accelerating

The acceleration in inflation is more evident when looked at in six-monthly blocks.

In the six months to the March quarter 2021, the annualised increase in the trimmed mean inflation rate was 1.7 per cent. In the six months to the September quarter 2021, the annualised increase was 2.4 per cent, which is the strongest rate of increase in this measure since the June quarter 2015.

A close-up of a fuel pump showing high prices. (Source: Getty)
A spike in fuel prices has added to inflationary pressures. (Source: Getty)

With inflation poised to rise further, as the economy rebounds from the lockdowns in New South Wales, the ACT and Victoria, and wages growth clearly on the upswing, it seems close to certain the annualised rate of underlying inflation will hit 3 per cent in the December quarter and will stay at that elevated level or move even higher during 2022.

The RBA has been pining for higher inflation for many years, even though it failed to do much to achieve this goal until the mayhem of COVID forced its hand to cut official interest rates to 0.1 per cent and undertake a range of quantitative easing measures.

These have worked.

RBA set to revise forecasts

Next week, the RBA will release its Quarterly Statement on Monetary Policy, which will include a revamp of its forecasts. Of most interest will be the extent to which its inflation outlook has changed from the benign forecasts in previous statements.

It cannot stick to its current assessment that low inflation will see it hold off hiking interest rates until 2024.

Pedestrians walks past the Reserve Bank of Australia in Sydney. (Source:Getty)
The RBA's current forecasts are unlikely to match the pace of inflation. (Source:Getty)

The facts have again overwhelmed the RBA’s judgment, so its reading of the economy and, more importantly its policy settings, must change.

The RBA must also be alert to the global inflation outcomes and risks that have seen dozens of central banks hiking interest rates in recent months, and that are sparking the markets to price in a series of interest rate hikes from the US Federal Reserve, European Central Bank, Bank of Canada, the Reserve Bank of New Zealand and Bank of England, among many.

Investors in Australia have also moved to price in interest rate hikes from the RBA from the current 0.1 per cent cash rate.

It is no longer appropriate to the current economic and inflation climate.

Expect rate hikes in 2022

At the moment, the market is pricing in a 0.5 per cent cash rate in August 2022, 0.75 per cent in November 2022 and 1.0 per cent in early 2023 and 1.5 per cent late that year.

This profile for interest rate hikes could be too timid given the coiled-spring of inflation pressures that have been building and are now showing up in the hard data.

Indeed, if underlying inflation hits 3 per cent early in 2022 and stays at that rate, let alone moves higher through the year, the RBA may be on track to hike by 2 to 3 percentage points over the next 12 to 18 months.

Inflation is rising and the economic crisis from COVID is over.

This means interest rates need to rise, and probably by a lot more than the market is pricing in.

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