OPINION: Rates must rise: Surging inflation makes a mockery of RBA's stance

A couple choose fruit at a farmers market as inflation hits fresh produce prices.
The March-quarter inflation results confirmed what has been blindingly obvious for some time. (Source: Getty)

The cost-of-living pain so many households are experiencing has been confirmed with the March quarter consumer price index.

Inflation rose by 2.1 per cent in the March quarter to be 5.1 per cent above the level of a year earlier. This is the highest quarterly inflation rate since the goods and services tax was introduced in 2000.

The trimmed-mean inflation rate, which excluded items with outsized, volatile and often-temporary sharp price changes, rose 1.4 per cent in the quarter to be 3.7 per cent above the level of a year ago.

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These inflation results confirm what has been blindingly obvious for some time - that inflation has smashed through the top end of the Reserve Bank’s (RBA) target band of 2-3 per cent, which makes a mockery of RBA governor Philip Lowe’s assessment - made earlier this month no less - that the bank wanted to see clear “evidence that inflation is sustainably within the 2-3 per cent target range before increasing interest rates”.

Humiliatingly for the RBA, having had five years with trimmed-mean inflation running below the bottom of the target range, it spent just two quarters within the target before zooming through the top end of the range.

It is hard to know the language the RBA will use at next week’s board meeting when discussing its staggering failure to meet its inflation target – this time on the top side.

With the fabulous news in the labour market, - strong growth in job vacancies, which is set to signal a fall in the unemployment rate towards 3.5 per cent in the months ahead - wages growth is poised to skyrocket.

This all boils down to a scenario where annual trimmed-mean inflation is set to be around 4 per cent through 2022 and 3.5 per cent through 2023 – and these forecasts build in an assumed 3 percentage points of interest rate hikes by the latter part of 2023.

Interest rate hikes are urgently needed

The RBA board meets next Tuesday, May 3, to consider monetary policy settings.

Quite clearly, it needs to hike the cash rate by at least 40 basis points to 0.5 per cent as it moves rates towards what will be an ultimate peak around 3 per cent.

Interest rate hikes will work as they always do. They encourage more savings and less borrowing at one level, but also see those with debt divert their cash flows away from spending and direct it to servicing that higher level of debt.

This will cool the level of demand in the economy and, with a lag, start to restrain inflation pressures.

As the RBA lifts the cash rate towards 2 per cent by the end of 2022 and beyond in 2023, the economy will come off the boil and inflation pressures will ease.

This is how monetary policy and interest rate hikes work.

There are, as always, risks around that scenario.

Residents stand on a Shanghai street waiting for COVID tests.
Recent COVID lockdowns in Shanghai and Beijing have contributed to China's slowing economy. (Source: Reuters)

The Chinese economy is slowing, temporarily it seems, under the weight of COVID-related lockdowns. The global economy is also likely to register less rapid growth, with many of the major central banks already hiking rates.

For now, Australia has an inflation problem. It is well above the top end of the RBA’s target and has little prospect of falling back to the target range without policy action.

The 0.1 per cent cash rate is horribly obsolete. At the same time, the Government is pump-priming spending, which is only adding to inflation pressures.

The policy solution is so obvious and easy – higher interest rates.

The RBA needs to start the long market to taking the action to contain inflation with an interest rate hike next week.

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