Inflation hits a new high: Here's what that really means

The RBA was spot on with its inflation predictions for the second half of 2022. So what does 2023 hold?

·4-min read
Composite image of money, and a woman shopping for groceries to signify inflation.
Skyrocketing inflation in 2022 hit the price of everything. But there is hope the cost of living will ease markedly in the next 12 months. (Source: Getty)

The annual inflation rate surged to 7.8 per cent in the year to the December quarter. This is the highest rate of inflation since 1990.

At a time when household incomes have risen by around 5 per cent, the reason for the cost-of-living pressures - which have fed into dismal levels of consumer sentiment - is obvious. Your weekly or fortnightly pay is buying less than it did a year ago.

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In terms of the key data on inflation, the Consumer Price Index (CPI) rose by 1.9 per cent in the December quarter, after a rise of 1.8 per cent in the September quarter. The trimmed mean CPI, which the RBA tends to focus on when setting monetary policy, rose by 1.7 per cent in the December quarter to be 6.9 per cent higher in annual terms.

While the result was high, it was broadly as the Reserve Bank of Australia (RBA) had been expecting for the past six months.In August 2022, the RBA was forecasting December quarter 2022 inflation to be 7.8 per cent, so the bank was spot on.

In November, the RBA revised this to 8.0 per cent - even with interest rate hikes of 125 basis points in total in September, October, November, and then December. This was a little too pessimistic but, in broad terms, the RBA called it brilliantly.

While inflation was the key economic issue for 2022, there was a hint of comfort that the December quarter data was the peak expected by the RBA.

Reserve Bank of Australia governor Philip Lowe smiles. The RBA's inflation predictions improved in 2022.
RBA governor Philip Lowe may have been way off the mark in early 2022 but he can be happy with his inflation predictions for the second half of the year. (Source: Reuters)

What went wrong?

The horror picture on inflation, which is a global phenomenon, is due to a series of events which kicked off in 2020 and early 2021. In particular, zero interest rate settings, money printing, massive fiscal stimulus and corporate lockdowns - which squashed the supply of many items - all fed into the inflation blow-out.

The tardiness in reversing these policy issues, as COVID vaccination allowed much of the global economy to reopen from the middle of 2021, made the inflation problem more extreme.

During the inflation surge in 2021, central banks judged the lift to be ‘transitory’ or, in the case of the RBA, it judged that inflation would not exceed its target until at least 2024.

This was a huge policy error.

What is going right?

The good news is that now, in early 2023, all of the factors that forced inflation to surge have gone into sharp reverse.

Inflation is set to free-fall. The smart money is on most central banks getting inflation back to their target levels by the end of 2023 or the early part of 2024. Australia and the RBA are in that camp.All major central banks have aggressively hiked interest rates and ended money printing. Budgets are being tightened, meaning government cash handouts linked to COVID are no longer in place and, indeed, cash is being sucked out of the economy as budget repair spreads.

Economic growth is therefore slowing, which will see demand-driven inflation pressures ease. Some credible economists are forecasting a recession in the US, Europe, Canada and the UK. Aiding this disinflationary pulse is a fall in commodity prices which, for many businesses, will see their input costs decline.

Supply chain issues are largely fixed. Delivery times for manufacturers are back to the pre-pandemic normal, freight shipping costs are down 80 per cent, to be around the rates they were prior to the onset of COVID.

Some very basic and simple economic models of inflation with these inputs are showing inflation falling sharply, with the only questions of note being whether it gets below 3 per cent during 2023 or in early 2024.

For the RBA, the debate on monetary policy is getting easier. Prudence is screaming “rates on hold” at 3.10 per cent as the economy absorbs the drivers of low inflation. This is despite the December-quarter data. If the RBA ignores these trends and hikes again, it will further damage its already-low level of credibility by having its fingerprints on an unnecessary economic hard landing.

Indeed, when the RBA Statement on Monetary Policy is released on February 10, its forecasts for inflation will likely revise lower over the medium term. Inflation was a 2022 issue – disinflation is the theme for 2023.

If the RBA does this, there is no need for a further interest rate hike or for a hard landing for the Australian economy.

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