Think Big: Sick of inflation yet? Wait, this time really is diff–(don’t say it)
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The inflation chatter has been incessant over the past month or so — to the point that you’re probably sick of it.
But we’re going to take another look at it because CBA reckons Australia is now “much more likely to see a lift in wages growth and consumer inflation over the next few years”.
Most of the debate in recent weeks has centred around US inflation, after the y/y April CPI print came in at a 13-year high.
This week’s annualised May print was even higher, but there was an interesting reaction – the bond market dgaf.
If inflation rose faster than expected, the chain reaction for assets would typically start in the bond market as yields rise.
Instead, benchmark US 10-year bond yields are back below 1.5%. So for now, bond investors appear to share the view of central banks globally — that inflation pressures will rise through the middle of this year, then fall back down.
CBA economist Joseph Capurso recently provided a useful framework of what to look for with each US inflation print through the middle of this year.
Breaking down the details of the last two US inflation prints, Capurso and other analysts have highlighted specific items (such as used car sales) that are dragging inflation higher, but will likely prove transitory.
For inflation to become more entrenched, most analysts also agree that a sustainable lift in wages will also be required — which is one of the areas CBA’s Australian economics chief Gareth Aird focused on in his latest analysis.
One of the reasons inflation is so topical is that no one quite knows what the fallout from the titanic post-COVID policy response will be, because it’s never happened before.
But in assessing the domestic inflation outlook, Aird said it’s now fair to make the statement that “this time is different”.
He used the same rationale in predicting Australia’s V-shaped economic rebound.
And in the wake of recent developments, he said it applies to the outlook for wages and inflation as well.
For starters, the Morrison government now expects Australia’s borders to stay closed until the middle of next year.
Aird expects that policy decision will act as a catalyst for wage growth, due to the following combination:
It’s much more difficult for employers to hire staff from abroad, at a time when workers are in demand, business confidence is at historic highs and economic growth is picking up steam.
Already, labour shortages are emerging across a number of industries. And the post-COVID border scenario makes for a “very different” dynamic, when supply was bolstered by strong migration growth.
Next, the fiscal playing field has fundamentally shifted. Yes, the Morrison government’s COVID-19 policy response was unprecedented.
“In many respects the May 2021 Budget will go down as the watershed moment, rather than policy decisions that were essential to support the economy in 2020,” Aird says.
For a whole political generation, the federal coalition has focused its policies around balancing the national budget.
Those days have now ended in a “radical shift” where major spending initiatives will take priority over balancing the books, Aird said.
Its end goal is to use “fiscal levers to run the economy hot, which will push the unemployment rate down”, he added.
Lastly, remember 2020’s year-end data which showed Australians had saved an extra $100bn due to the pandemic?
Aird says it hasn’t reversed yet. Through the March quarter, CBA estimated the lift in domestic savings stood at around $140bn.
Importantly, the savings outcome is not one that households chose voluntarily. So in that context, it’s “reasonable to assume” that households will spend their extra cash when the time is right.
Even a partial drawdown will see “demand for certain goods and services lift more quickly than usual. As this happens, we will see some demand-pull inflation”, Aird said.
While the government’s May budget may have been a “watershed” moment, the policy shift by the RBA (and other central banks) has also been historic.
Instead of basing interest rate settings on forecast inflation, monetary policy makers won’t shift rates until they see evidence of actual inflation. Not only that, actual inflation that’s rising sustainably.
It’s been highlighted before, but it’s a huge shift that’s worth reiterating.
And Aird says that for one thing, it means we are “more likely to see higher wages and inflation outcomes” because the RBA won’t move rates based on what it thinks will happen — those outcomes actually have to happen first.
Broadly speaking, the inflation debate is important because CPI growth hasn’t risen meaningfully for almost 50 years. So it could prompt some tectonic shifts in market structure if it does run hot.
The risk flagged by some analysts is that central banks may be forced to play catch up if CPI gets off the hook, and raise rates faster than previously expected.
In a market with liquidity settings based on rock-bottom interest rates, that’s likely to have an impact.
“At this stage we consider that risk to be low,” Aird said.
“But it could materialise, particularly if fiscal policy was to remain very expansionary while the economy was running at full capacity.”