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Is inflation about to slump?

·4-min read
Composite image of a petrol bowser and an oil rig to signify inflation.
Commodity prices have dipped below recent peaks, suggesting an abatement of inflation pressures in the months ahead. (Source: Getty)

Economic outcomes - including for inflation - take some time to turn. In other words, it can be many months - up to a year in some circumstances - for the effect of policy changes and market forces to bring about a turning point in the world and Australian economies.

This is the sort of time frame in place for inflation to return to more normal levels in the current cycle.

Also by the Kouk:

Even allowing for this time frame, when there is an economic problem - such as inflation at the moment - it is important to look for indicators and information that highlight turning points in economic conditions.

This ‘early warning’ analysis can lead policy makers, businesses and investors to make better decisions, and for the longer-run trend performance of the economy to be better than it would otherwise be.

Inflation is at a 30-year high, but for how long?

In terms of inflation, the path to a further near-term acceleration is pretty much baked into the second half of 2022, such are the obvious pressures on prices across the board.

Cost-of-living pressures will see inflation hit a 30-year high, around 7.5 per cent, by the December quarter, 2022.

There is not much that can be done by policy makers or within markets to reverse this within the next few months.

They can, however, influence what happens in 2023 and beyond.

That said, there are some tentative signs emerging that suggest the rate of inflation will start to ease, perhaps significantly, into 2023. The RBA may well be rejoicing this time next year as inflation rapidly descends towards its target range of 2-3 per cent.

Importantly, a range of global commodity prices are falling. It is early days to be sure, and the pass-through of commodity prices to consumer prices can be erratic, but the fact that the price of oil, natural gas, copper, nickel, wheat, corn, timber – to name a few – are all materially lower than their recent peaks points at an abatement of inflation pressures in the months ahead.

Without wanting to trivialise the issue at the local level, lettuce prices, along with a range of other vegetables, are certain to fall in the next few months as the flood impact on production passes and growers ramp up their output to normal levels.

This will see prices for vegetables fall and will start to impact inflation by the December quarter.

There are also signs that global freight shipping charges are falling, which should in time feed through to an easing in pricing pressures for many businesses.

Indeed, just about every indicator that was driving inflation higher from late 2021 is now either topping out or are starting to fall.

In the months ahead, the economy will also see the impact of further RBA and global interest rate hikes. These will dampen demand, including for household spending, which will discourage businesses from hiking their selling prices as the economy slows.

This is how monetary policy works.

It is also apparent that the so-called wealth effect on householders is fading as house prices ease and the falls in share prices impact household spending, especially into next year.

The wealth effect was one reason household spending had been so strong and inflation was easily passed on through the economy over the past year.

While all forecasts for inflation are fluid and subject to significant variation, as global prices fluctuate, the path for a significant slowing in inflation in 2023 seems assured.

The main questions are: How quickly will inflation slow? How low will it go? And how long will it remain within the RBA target range?

At this stage, it is on the cards that after peaking around 7.5 per cent later this year, annual inflation will ease back to around 4 per cent by the June quarter, 2023 and 2 per cent by the December quarter, 2023. It is likely to hover around 2.5 per cent in 2024.

If so, this should see the RBA’s interest-rate-hiking cycle top out around 3.25 per cent in early 2023 and for discussion to emerge about rate cuts in 2024.

That is a story for another day.

But, for now, while inflation pressures will remain acute for the next few months, the outlook is rapidly evolving to the point where inflation will ease, which will see cost-of-living pressures abate.

Importantly, real wages will jump as inflation falls.

It will be good news.

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