For the best part of 20 or more years, global inflation has been low.
In the last decade, inflation has actually fallen to levels rarely seen in modern economic history.
This has seen official interest rates around the world fall to near zero. Government bond yields in many countries have been negative in an extraordinary market move that was in large part driven by low inflation.
These dynamics have sparked a surge in asset prices with stock markets booming and housing prices across huge parts of the world rising at a staggering pace.
Inflation pressures are building
In early 2021, inflation around the world started to pick up.
Part of the reason was the economic recovery as COVID restrictions were eased, but more importantly, a series of supply chain bottlenecks saw severe shortages in a range of every days goods – cars, food, energy, computer chips and even cardboard boxes, among many things.
The bulk of market participants and importantly, central bank officials, viewed this inflation lift as ‘transitory’.
This meant that talk of interest rate hikes was quickly extinguished, government bond yields fell back and stock prices surged as the market stood by waiting for the inflation data to drop back to where it was before the current spike.
At this stage, there is little evidence of this disinflation impetus coming through.
Indeed, if we look at a range of global commodity price measures, inflation pressures are actually intensifying.
The price of many metals, oil and gas and a range of agricultural products are at multi-year highs.
WATCH: 3 facts about the Australian property market.
There seems little doubt that inflation will remain materially higher than all central banks have been planning for as they maintain official interest rates near zero and their massive intervention in bond markets.
Speaking of the bond market, it is a great barometer of what is ahead for the economy in general and for inflation in particular.
Bond yields inevitably react to economic trends well before central bankers and in the past month or so, the sell off has resumed with yields rising.
The reasons for this are linked to a realisation that inflation is not falling back to pre-2021 levels and that central banks are likely to be tardy in winding back much of the monetary policy stimulus currently in place.
If what the markets are telling us about the inflation outlook is the start of a more dramatic move, then the 2022 policy discussion will be about timing and magnitudes of monetary tightening as central banks work to maintain their credibility as inflation targeters.
At one level, this should not be a concern for the Australian economy. It generally benefits in times of higher global inflation as commodity prices are skewed higher. Near zero interest rates and bond buying cannot continue forever.
Indeed, the RBA stepping back from the bond market and materially higher interest rates would be a good thing.
On another level, there are implications for the cyclical element of housing and house prices in particular, as monetary policy is potentially tightened over the next few years.
2022 is shaping up as year where house prices fall
There remains a pipeline of an extraordinary increase in new dwelling supply. The building approvals data show a huge lift in new construction which will be completed between now and the end of 2022.
Immigration is still negative.
The banks are tightening their lending standards which will limit the extent to which borrowers can gear up.
All of which suggests that house prices will not only stop rising in 2022, but could fall.
The extent of price falls will be determined by how forceful the negative influences are. At this stage, economy-wide falls of up to 10 per cent are probable, as a surge in supply relative to demand and tighter credit start to bite.
When this happens, it will be higher inflation and tighter monetary policy that will share some of the blame.