Rates Will Need to Go Higher to Tame Inflation
Brendan Giles
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The RBA will all but certainly be raising interest rates again this afternoon (by 50 basis points to 2.35%) and there have been various commentators suggesting that it's time for a pause in rate increases, or we are approaching the peak.
I don't think this is right, bond market expectations for peak rates have been pegged between 3.6% and 4.0% for months now and, there are strong indicators that the fight with inflation is far from done.
Let's run through a couple...
Petrol Prices are Going Back Up
Petrol prices have retreated somewhat from their highs in June, but petrol prices in Australia are set to go back up over the rest of 2022, for two reasons.?
First, the Liberal’s vote grabbing petrol excise but will end on 28 September. Instantly adding 23 cents to the cost of a litre of petrol - this is good for a 0.25% jump in CPI all on its own.?
Second, overnight OPEC+, the cartel of oil producing nations decided to cut oil production to boost prices. This cut will take a few weeks to work through the international trade system, but is worth a another 4 to 6 cents per litre by the time it gets to bowsers in a few weeks.?
There isn't much hope of relief in 2023 either. Sooner or later China will have to abandon their pursuit of COVID-Zero and when they do, we will see a significant spike in demand for oil from China.
The Explosion in Rents Hasn’t Hit Inflation Yet
Australia’s rental crisis is no secret but the steep rises in rent are yet to flow through to official CPI numbers. Rents in major capital cities are up 19.5% YoY and are likely to go higher as over leveraged investors push up rent to cover for rising interest costs.
When the full rental rise flows through to inflation, it will account for another 1.2% increase in CPI all on its own.
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Wages Growth is Slowly Picking Up
While wage growth remains well below inflation, there are signs that workers are starting to receive wage increases to catch up with inflation.
Wages across all industries were up 3.3% last quarter and NAB’s more recent business survey reported labour costs growing at 4.6% in July. While this is better news for workers, as it trims declines in real wages, it will also place continued upward pressure on inflation.?
This is another trend that will not be going away anytime soon. With unemployment super low, and workplace participation near all time highs, there's going to be increased pressure on wages for the foreseeable future.
The USD is Dominant
The US dollar is currently at all time highs against other currencies and is due to climb higher, with the US Fed more aggressively raising rates than the rest of the developed world and capital continuing to move to the safe haven of the US dollar.?
With so much of international trade denominated in US dollars, the continued weakening of the AUD against the USD will mean higher import prices and further inflation pressures in Australia.?
Most Mortgage Holders are Immune to Rate Increases (For Now)
Most Australian mortgage holders just aren’t being impacted by rate increases yet. More than 40% of mortgages are fixed at ultra low rates and will remain there for almost two more years, while 35% of those on variable rates would seen no impact to their repayments from a cash rate at 3.35%, due to pre-payments, large offset accounts, or voluntary extra repayments.?
With so much of the mortgage market effectively immune to interest rate increases until the cash rate gets to around 3.5% the RBA will be forced to go higher with interest rates to bring inflation under control. This is going to be very hard on the approximately 28% of variable rate mortgage holders who are very susceptible to rate increases.?
Retired.
2 年It strikes me that the RBA is not giving its previous rate hikes time to have an effect due to the delayed implementation by the Banks. Previously, rates would be increased this month, then an assessment made down the track a little way to see if the increase is having any effect. Now it seems its full steam ahead with increases no matter what - don’t worry about driving people to bankruptcy and businesses to liquidation. Seems these are these increases we have to have and bugger the consequences.
Managing Partner at Spartan Partners
2 年There are ~23million TEU across the entire global shipping fleet today. There are ~5.8million TEU's about to hit the water (or the global shipping fleet will increase by +25%). This is the fastest growth of shipping container capacity in all of history. Shipping prices are going to utterly collapse back down to long run averages - and likely further below.
Managing Partner at Spartan Partners
2 年Lastly, 40ft container shipping cost benchmarks are dropping week-on-week since the beginning of the year. They have fallen ~47%. This is on account of the reactivation of a lot of planes (temporarily mothballed due to Covid). A vast amount of cargo fits in the belly of a plane. The cargo subsidises the passengers, and the passengers subsidise the cargo. There is also another graph which shows the TEU's about to hit the water in the coming 12mths. Cargo ships experienced their fastest construction period over 2020-22. The water will be flooded with increased supply. Prices will continue to crash and this will have momentum in to prices of finished goods and their cost to import. Then you have literally every commodity, industrial, agricultural, horticultural product falling over the last 3-6mths. A few per below: - Wheat down -37% - Corn down -19% - Copper down -29% - Timber down -67% - Steel rebar down -26% The list goes on here in Australia with Kiwi Fruit, Bananas, Avocados (down -40%), Apples, Pumpkins, Broccoli, Milling Wheat, Feed Wheat, Cereal Hay, Lucerne Hay, Canola (huge drop), Feed Barley (huge drop), Beef, Mutton (huge drop), Lamb, Live Cattle (huge drop)...the list goes on - only item that has increased is Goats
Managing Partner at Spartan Partners
2 年Quick few points / corrections: * The RBA does not react to headline inflation. It reacts to trimmed mean inflation (removal of temporary shocks). As an example, lettuce exploded from ~$2.5 to $12 per head, this was not due to demand but floods in QLD. Lettuce has since near fully retreated back to its long run average with increased crop yield. * The cut to fuel excise took place on the 29th of March 2022 when Tapis (our primary benchmark) was trading at close to $120 but today is $101 (and has tested periods below $100). So it is trading close to 16% cheaper. Weakness in Europe and China will see WTI trade close to $90 with high downside risk to $80. The US Administration leading to Mid Terms in Nov22 need it as low as possible. New arms deals with the Middle East will guarantee short term price drops through to 2023-24. * Wages are growing, but nowhere near enough to trigger prolonged momentum generating inflation. Our wage growth is also nowhere near international peers that have experienced the bulk of inflationary pressures. * Not quite also on the USD argument either. The AUD to USD was 68c in 2019 and is 68c today - no movement at all. The USD appreciation is just causing havoc with developing nations
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2 年This is a great summary - history shows it’s likely to be higher rates as supply side inflation feeds on the economy which in turn signals the RBA to keep going up. If Milton Friedman and Paul Volcker were right, we have a long way to go with interest rates playing catch up.