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Inflation surge demands further interest rate rises

·3-min read
RBA governor Philip Lowe discussing inflation and interest rates.
RBA governor Philip Lowe has more work to do to bring inflation back down. (Source: Getty)

As the inflation rate booms to equal its highest level in more than 30 years, there is only one option for the RBA – keep hiking interest rates.

The annual inflation rate rose further to a fresh cyclical high of 6.1 per cent in the June quarter. The trimmed mean measure - which looks at a narrower set of price changes by excluding items that experienced largely one-off and extreme moves, rose by 4.9 per cent.

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Recall that the target for the RBA is to have annual inflation between 2 and 3 per cent, on average, over the medium-term cycle.

It is a long way off that goal following Wednesday’s data.

Two years ago, annual inflation was -0.3 per cent as the depths of the COVID-19 recession and a range of government measures drove overall prices lower.

The 6.4 percentage point jump in the annual inflation rate over those two years – from -0.3 per cent to 6.1 per cent - is the most extreme two-yearly increase in inflation since 1986 and the second-highest since 1975.

We are in uncharted territory in the modern era of inflation targeting.

Already, the RBA has hiked official interest rates by 125 basis points, but rates are still at a very accommodative 1.35 per cent.

Next week, the RBA Board meets again and this inflation result should see it go hard, with a 75-basis-point move so it can play some catch-up to where policy should already be to get inflation back under control.

With the very tight labour market - unemployment at a 48-year low of 3.5 per cent and a record-high 64.4 per cent of the working-age population in employment - it should have no valid reason not to move aggressively.

As is always the case, it is unclear how high interest rates will need to go to bring inflation back to the target range or, indeed, when that peak in rates will occur.

The money market futures are pricing in a peak rate around 3.5 per cent in the middle months of 2023.

This looks a little too high given the signs that, despite the latest CPI figures, global inflation is peaking and could start to decelerate in the latter months of 2022.

Commodity prices are generally off their highs - oil in particular has fallen more than 20 per cent in the past month and this is showing up in retail petrol prices. If sustained, it will clip a point or two off inflation in the medium term.

Lower prices for timber, metals and many agricultural products will, if sustained, see broader inflation pressures ease.

Many of the supply chain issues are also being resolved. Freight shipping costs, microchip prices, car production and manufacturing delivery times are all starting to ease from the extreme levels of 2021.

For now, Australia has a severe inflation problem. It is likely to lift further by year’s end, reaching 7 per cent or more.

It will take careful navigation from the RBA and Government to get inflation lower without there being serious fallout for the broader economy.

A few more interest rate hikes in the next few months is appropriate and, if it can get the cash rate to 2.5 to 3 per cent by year’s end, it can likely pause and assess the effect of what it has done, judge the pressures coming from the global economy as other central banks hike further and look at what the Government does in the Budget to help easy cost-of-living pressures.

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