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Are we heading for the worst period of inflation ever?

Michael Yardney and Dr Andrew Wilson discuss the weekly update on the Australian property market.

Video transcript

MICHAEL YARDNEY: What a week it's been. The Reserve Bank Governor, Philip Lowe, appeared on ABC and told us inflation is likely to get to 7% by the end of the year and that the Reserve Bank had no choice but to hike interest rates to bring down prices. Not surprisingly, the media's been full of negative messages, and consumer sentiment plummeted. I guess there's all those concerns about rising interest rates and the possibility of a recession.

Also during the week, we had a big jump in the minimum wage, a 75 basis point rise in the interest rates in the United States and strong employment figures locally. And Governor Philip Lowe made some forecasts about inflation and about interest rates, which I'm going to discuss in this week's Property Insider chat with Dr. Andrew Wilson, Australia's leading housing economist. And I'm interested to hear his views, because I know he's got some concerns about taming inflation. Meaning that we could be in for the worst period of inflation ever. Hi, Andrew.

ANDREW WILSON: Hi, Michael. How are you?

MICHAEL YARDNEY: I've been well, Andrew.

If we go back to what happened during this week when the Reserve Bank governor went on TV, I think part of what he was doing was trying to lower consumer sentiment, stop demand. Because really, he wants to stop us spending. One way that he's going to do that is take more money out of our pockets by raising the interest rates.

But he said the board received plenty of criticism on how its interest rate policy had played out. He reminded us that, in 2020, Australia was facing Armageddon prospects of tens of thousands of virus deaths, 15% unemployment. Inflation expectations were in the gutter at that stage. But now he's telling us he's expecting inflation to hit 7%, and even by the end of this year. And he also suggests that interest rates, the reasonable rate, could be 2 and 1/2%. That's, of course, the cash rate, which means the rate you and I pay for our mortgages would be a couple of percent higher than that.

ANDREW WILSON: Well, I think he will be lucky to get away with his predictions of inflation. I think they may even go higher, unfortunately. Michael we're seeing no easing of inflationary pressures in the US. Look, Australians and most advanced economies were all paid forward, Michael, through the pandemic with a raft of stimulus packages. And now we've just got to pay it back, Michael. That's what's happening.

And unfortunately, it's going to mean some tough times. And at the end of the day, the increasing likelihood is that we're going to see unemployment rising sharply as a result of the Reserve Bank slamming on the brakes, which I think it will do now and perhaps follow the example that was set by the US. Last week it raised official rates by 0.75 of a percent, which is the highest since the early '90s.

And we've only ever raised it once by 0.75%, Michael, and that was also back in the early '90s. So it would be a record increase in official rates if we did get that 0.75%. But there's no use mucking around now. You've got to go hard, and you've got to go early.

The question is, will it work? And I think that that's becoming even more problematic, that we may get into that position of stagflation, where we have high inflation and lowering growth. And I think the big concern rising now, in terms of inflation, not just the cost of oil, the big concern now, Michael, is food. And I think that's where we're going to see, perhaps, the emergence of international food shortages. We're already seeing that now. And Australians are experiencing food shortages now in certain items that will only increase inflationary pressures.

MICHAEL YARDNEY: Of course, they've got further reason to increase the interest rates next month, like you are suggesting, because currently there's a jobs boom and the tightest labor market in 40 years with the latest ABS statistics coming out showing what's happened over the month of May.

ANDREW WILSON: The number would have been actually lower if we had of had the same participation rate that we had the previous month. But we-- the participation rate increased to a record. Over 2/3 of the population were employed, and that's a record. So that actually pushed the rate up a little bit, because we had more people coming into the workforce.

The question is whether we can drag more people out of the population into the workforce to keep the economy growing or whether we have reached its peak. Of course, we had 60,000 jobs created over the month. But when we look at the April number, it was just 4,000 jobs created. Perhaps it was a little bit of a bounce-back over May.

But my sense still is that we may struggle to get that 3 and 1/2% unemployment rate that the bank is predicting at the moment. And we may have just sort of peaked in terms of the unemployment rate and the participation rate and jobs growth, and particularly given that we're now certainly seeing some more significant signs of migration picking up in Australia. And that'll mean more supply of labor.

MICHAEL YARDNEY: Another important bit of news over the weekend, Andrew, was the Fair Work Australia's decision about raising the minimum wage in Australia. That's going to have quite some implications, isn't it?

ANDREW WILSON: Certainly the decision was on the upside in terms of the quantity that the wage commission has nominated. Basically is now matching inflation with the minimum modern awards and also the minimum wage. I mean, their argument always is to avoid poverty, a particularly inflationary environment, that you can't marginalize those minimum workers.

But, of course, the concern here is that it will-- higher wages will fuel inflation. And that's the real danger in an inflationary environment, is that you start getting wages chasing prices. And then it becomes the dog chasing its tail. And the dragon really does get out of control then.

But what will be interesting, Michael, is how the wage commission acts if we don't get inflation under control. Is this a precedent in terms of matching inflation with wages? Because as I said, we've got to pay this back now, Michael. If we keep trying to pay ourselves more and keep up with inflation, it will just fuel inflation going forward. We have to go through a period of hardship. That's why current rates have been increased, Michael. It's putting the foot on the brake. And we do know that the outlook must be for reduced activity. Because that's what the Reserve Bank's plan is, is to put on the brake and keep its fingers crossed so it's not a hard landing.

MICHAEL YARDNEY: Well, we're going to hear a bit more from the Reserve Bank over this coming week.

ANDREW WILSON: Yes.

MICHAEL YARDNEY: So we'll have more to discuss when we catch up next week in next week's Property Insider video. Thanks for your time, Andrew.

ANDREW WILSON: Thanks, Michael.

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