INFLATION CURB PROVING A TOUGH TASK

Inflation. Everyone’s talking about it, especially now that it’s so high.
 
Consumer prices are soaring, materials too.
 
Stockmarkets sweat on latest inflation figures, while mortgage-holders and corporate lenders wonder how far banks will lift interest rates in the wake of emerging inflation trends.
 
Part of the pain of the latest jump in inflation can be attributed to how quickly it’s risen.
 
In Australia, for example, inflation as measured by the Consumer Price Index was actually negative – that’s minus 0.3 per cent – in the 12 months to the end of June 2020, as the economy slumped during the first wave of Covid-19.
 
By December 2022, however, annual CPI inflation as measured by the Australian Bureau of Statistics had leaped to 7.8 per cent.
 
Post-Covid supply chain and worker shortages have been blamed, as well as the effect of local flood events on domestic food prices. And of course, the Russian invasion of Ukraine has contributed to higher worldwide energy prices and increased global demand for food.
 
For the Reserve Bank of Australia, it’s been a major shock as well.
 
In the last 12 months, it’s had to lift its cash rate target from almost zero to 3.6 per cent, in a bid to contain resurgent inflation.
 
To be fair, the RBA has played a central role in keeping inflation relatively low since the mid 1990s.
 
In the early 1980s, inflation was regularly in the double-digit levels, dropping to around three per cent only when the economy slumped into recession in 1982-83.
 
But when the economy recovered through the 1980s, so did inflation, falling only when the 1990-91 recession caused a sharp drop in economic output.
 
That’s when the RBA established an inflation target of 2-3 per cent as the basis for monetary policy. This target was formalised in 1996 in an exchange of letters between the then Treasurer, Peter Costello, and the then RBA Governor, Ian Macfarlane.
 
Zero inflation is uncomfortable because it implies that the economy is not growing sufficiently.
 
In 2014, then Secretary of the Federal Treasury, Dr Martin Parkinson, lauded the success of the inflation-targeting framework, noting that it had coincided  with a “period of remarkable growth in the economy.”
 
But in the last 12 months, inflation has quickly jumped well above the 2-3 per cent target range, leading to the RBA’s aggressive moves to peg back inflation.
 
Of course, inflation is not confined to Australia.
 
The United States, for example, is also battling inflation; like Australia, the Federal Reserve has lifted the target range for the federal funds rate to 4.75 per cent to five per cent, to curb rising prices.
 
US inflation for the 12 months to the end of February, as measured by the Consumer Price Index, increased six per cent (unadjusted), with housing and food costs continuing to rise.
 
Twelve months ago, optimistic political commentators and economic analysts would have been hoping that one-off or short-term factors behind the inflation spike - such as the Ukraine invasion and post-Covid supply chain disruptions – would quickly subside.
 
Rising prices can quickly become embedded, once businesses, consumers and governments factor expectations of sustained higher inflation into their budgets.
 
Australia’s inflation outlook will become clearer on March 29, when the ABS is due to release its monthly Consumer Price Index indicator, ahead of the more comprehensive quarterly CPI figures due for release on April 26.
 
A sizeable drop in the rate of inflation will be welcomed with relief by policymakers.
 
If not, the Reserve Bank has made it clear that it will continue to use monetary policy (i.e higher cash rate) to suppress inflation, back to its 2-3 per cent long-term target range.
 
As history shows, the alternative – plummeting inflation under an economy in recession – might be too painful.
 
 
Gavin Clancy is a Senior Consultant with Lunik