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Inflation still rising but there is good news for 2023

Composite image of empty supermarket shelves and money, to signify inflation and supply chain issues
Supply chain issues led to shortages of many goods and added to inflation. (Source: Getty)

When the December-quarter inflation data are released in late January, it will show the horror for households and businesses alike, that consumer prices have risen by around 8 per cent in 2022.

A ‘horror’ because the inflation rate is a broad cost-of-living measure that shows how much average Australian households' costs have risen. The experience of 8 per cent annual inflation reinforces why the Reserve Bank of Australia’s (RBA) target of 2-3 per cent is such a fabulous policy.

Also by the Kouk:

At 8 per cent, inflation will be the highest rate in more than 32 years and it is having a negative effect on consumer sentiment and spending growth. When people are spending 8 per cent more for the same basket of goods and services while wages growth is about half that, the pressure on consumer finances is obvious and acute.

It also means less spare cash for spending elsewhere in the economy, which is one key reason why the economy will slow into 2023.

It is also why the RBA is doing the right thing by hiking interest rates to slow the economy and bring inflation back under control. Low inflation is the best way to improve the cost of living.

Lower inflation is around the corner

There are many good reasons to expect the December quarter 2022 data to be the peak in inflation.

There are a wide array of indicators showing that inflation will not only fall through 2023 but will drop back towards the RBA’s 2-3 per cent target about as quickly as it rose from below 2 per cent to 8 per cent in 2021 and 2022.

In no specific order, those indicators are:

Commodity prices

Commodity prices rose around 165 per cent from early 2020 through to the middle of 2022. This extraordinary price boom fed directly into production and distribution costs, which in turn spurred the surge in inflation. Since that peak, the Commodity Research Bureau index of commodity prices has dropped 18 per cent, a move that will not only cap but will lower business and other costs.

Within the commodity price falls, from the recent peaks in US dollar terms, oil is down 38 per cent, copper down 22 per cent, wheat down 43 per cent, steel down 30 per cent, cotton down 42 per cent and lumber down 71 per cent.

Supply chain

Supply chain issues led to shortages of many goods in 2021, which fed into prices as demand remained strong. These issues are largely fixed. Freight shipping costs have fallen 80 per cent from their peak and are now broadly at pre-pandemic levels. Delivery times are also at pre-pandemic levels, semiconductor chips are no longer in short supply and motor vehicle production is also back to normal. These trends will show up in flat to lower retail prices, particularly in a competitive environment.

Slower global and domestic economic growth is the other key to lowering inflation. With a downturn in demand, businesses will be reluctant or unable to pass on higher prices and may even discount – lower inflation in other words – to maintain their market share.

Inflation in 2023 and 2024

The RBA, Treasury and financial market economists are all forecasting lower inflation over the next 12 to 24 months. The hot debating point is how quickly inflation will fall and the low point it will eventually reach in the down cycle.

There is more than the usual amount of uncertainty regarding the trajectory for that disinflation given the complex mix of factors that feed into inflation pressures, both up and down.

The RBA is forecasting inflation to fall but to remain a little above 3 per cent, the upper bound of its target, in both 2023 and 2024.

This looks too high given the mix of disinflationary pressures noted above. It is distinctly possible, if not probable, that by the end of 2023 inflation will be tracking nearer 2 per cent - especially if commodity prices continue to track lower on the back of the global slowdown. It could be even lower.

If this turns out to be the case, the pressure on the RBA monetary policy settings will turn 180 degrees – from tightening policy to easing it.

It is too early to sensibly or constructively be forecasting interest rate cuts but watch out for the markets to move in this direction as the evidence builds that shows inflation is falling.

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