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Inflation is “the key macro debate” in global markets, Pepperstone analyst Chris Weston said yesterday in a note to traders.

This week, the International Monetary Fund (IMF) warned that central banks across the world need to be “very, very vigilant” about the risks of rising inflation.

It’s been that way for a number of weeks now, and markets are starting to react.

For a number of advanced economies (including the US and Australia), yields on two-year bonds are starting to climb as markets assess the outlook for interest rate hikes.

Those market changes are taking place even though Australia’s central bank, the RBA, remains steadfast in its view that it doesn’t expect rates to rise until 2024.

Some tension is beginning to emerge in what central banks are saying and what markets are doing.

Will inflation in Australia rise faster than the RBA thinks? Economists at Commonwealth Bank think it will — and a key reason for that is the housing market.

The housing component of inflation

House prices in Australia are booming, and macro-prudential restrictions won’t stop them climbing, UBS says.

Inflation is complex tapestry of different components (87 to be precise), but housing makes up one of the larger sub-categories.

“Housing accounts for just under 23% of the CPI, so trends in housing inflation have an important bearing on overall inflation,” CBA economists Kristina Clifton and Stephen Wu said.

And there is “a lot going on”.


The largest component of housing inflation concerns the costs associated with building them.

Clifton and Wu said CPI growth in this area over the next 12-18 months will be the subject of competing forces.

On the one hand, the federal government’s HomeBuilder grants will help keep new dwelling purchase costs lower.

On the other, “strong domestic and international demand for materials, as well as skyrocketing shipping costs have all contributed to the solid rise in home building input costs”, the pair said.

Prices for timber — a key input for housing construction — are rising, as are steel prices.

“Reports of stronger wage pressures have also been a factor”, with labour shortages partly stemming from Australia’s border controls.

Typically, construction gets underway fairly quickly once a dwelling has been approved (around one month later). But in the March quarter, a large gap opened up between commencements and approvals.

Weighing it all up, Clifton and Wu said the impact of housing grants will help ease inflationary pressures in the months ahead. However, “we expect inflation in this category to lift in 2022”, they said.


The other big component of housing inflation is rental costs. Like construction, it’s the subject of competing forces.

In the aftermath of the pandemic, rents fell as post-COVID rent-relief policies were implemented and supply outpaced demand.

However, “more timely data are showing upward pressure on rents”, Clifton and Wu said.

Advertised rents have risen strongly since late last year, and CBA’s internal account data also indicates an increase in rents paid.

A key leading indicator for rental inflation is house prices themselves.

“Relative to rents, housing prices are very high,” the pair said.

“Rents and dwelling prices typically move in the same direction, and given the strong lift in dwelling prices it looks like rents will lift.”

Offsetting that is the fact that while Australia will soon commence a phased re-opening of its borders, immigration levels and population growth will take some time to return to pre-COVID levels.


The CBA analysts are also keeping an eye on essential housing utilities such as water and sewerage, and electricity and gas.

They noted there was a big drop in electricity costs in the December quarter last year, due largely to a one-off $600 household electricity credit in WA.

The Australian Energy Market Commission (AECM) expects electricity costs to stay muted in FY22, before climbing in FY23 due to the closure of the Liddell power station.

Inflation outlook

Like most things inflation related, drilling in the detail results highlights the complexities involved in forming a view on its future direction.

But on balance, Clifton and Wu reckon inflation forces from each of the three components outlined above will lean to the upside over the next 12-18 months.

In turn, housing inflation will contribute to CBA’s forecast that core CPI growth in Australia will climb to 2.25% by the end of next year.

For its part, the RBA thinks that number will be 1.75%.

And the difference between what the markets think and what the central bank thinks will continue to be an important theme in the months ahead.