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OPINION: RBA must raise interest rates next week

·3-min read
Above view of shopping bag full of fresh vegetables and fruits with milk and eggs on home kitchen counter.
Underlying inflation measures the change in the price of a basket of goods and services. (Source: Getty)

The annual rate of inflation rose by 3.5 per cent in the December quarter - the fastest rise since 2008 - and Australia's central bank needs to act now to contain it.

This spike is linked to the surge in global inflation, widespread skills shortages and is a response to super-easy monetary policy from the Reserve Bank (RBA), where official interest rates are set near zero and money printing is running rampant.

Also by Stephen Koukoulas

The underlying inflation rate - the more relevant rate for monetary policy settings - measures the change in the price of a basket of goods and services purchased by Australian households, but excludes items where there has been short-term extreme change.

This rate rose by 1.0 per cent in the December quarter after rising 0.7 per cent in the September quarter to be 2.6 per cent up in the past year.

What is most important is reading where the inflation momentum is going. The annualised underlying inflation rate over the past two quarters was 3.4 per cent, exceeding the top end of the RBA target range for the first time in about a decade.

And given what we know about global inflation, local price pressures and the start of a wages pickup, inflation will get even higher in 2022, staying above the RBA target of 2 to 3 per cent and forcing the hand of the RBA to hike interest rates.

Interest rates need to rise

The inflation data confirm the key issue that the RBA needs to increase official interest rates.

A rate hike should occur next week, when the RBA board meets.

It was all very well for the central bank to cut the cash rate to 0.1 per cent when inflation was below target, the coronavirus threat was extreme and the unemployment rate was expected to exceed 10 per cent, and possibly even hit 15 per cent.

At that time, the global economy was in turmoil and other central banks were cutting interest rates to zero or less and engaging in extreme quantitative easing (QE).

But now, we know inflation is above the top of the target and will move higher.

The unemployment rate is close to a 50-year low at 4.2 per cent. Other central banks are ending QE, they have or are just about to hike interest rates and while the global economy is far from perfect, it is still growing at a decent pace.

To cap it off, wages growth is about to lift, making the 0.1 per cent cash rate horribly obsolete.

The RBA board meets next week. On its agenda will be the ending of the bond-buying program, which is several months too late, as well as a discussion on pressures to adjust the cash rate.

Obviously, it needs to set the groundwork for getting the cash rate to around 2.5 to 3 per cent, which is seen as the neutral cash rate for a well-run and solidly growing economy.

It shouldn’t do this immediately, of course, but it needs to signal higher interest rates so that inflation is capped at 2.75 to 3.25 per cent over the medium term.

And the current 0.1 per cent is clearly not that rate.

All of which is food for thought as Australians face the mix of inflation pressures, the certainty of higher interest rates and an election.

Hold on to your hats. It will be a fascinating few months ahead, with so much at stake.

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