Inflation, rates and the RBA’s tricky choice

Sam Hawley: Hi, I’m Sam Hawley, coming to you from Gadigal land. This is ABC News Daily. We already know we’ve been paying a lot more for petrol, rent and electricity, but now we also know the price of those things could mean we’re slapped with another interest rate rise. That’s because the cost of those items is keeping inflation higher than the reserve Bank would like. Today, business editor Ian Verrender on what the RBA board is likely to do when it meets on Melbourne Cup day, and why it needs to tread very carefully.

Sally Sara (news clip): A Melbourne Cup day interest rate rise is looking more likely after official inflation data has come in worse than expected. The consumer price index jumped by 1.2% in the quarter, making it 5.4% over the year.

Sam Hawley: Ian, let’s talk about what these inflation figures might mean for interest rates in a moment. But first let’s unpack them. What do they mean they don’t look that good.

Ian Verrender: Well I think from an overall perspective you’ve got to take it from where we were and where we are now. So in December last year, we had inflation peaking at around about 7.8 per cent, and we’re now down to 5.4 per cent and it’s come down each quarter. We went from 7.8 down to 7, down to 6 and now down to 5.4, but it was only a little bit more than what was expected from the market. So everybody expected an annual rate of 5.3. And it came in at 5.4.

Sam Hawley: But Ian, we’re also looking at quarterly inflation. And that actually increased didn’t it? By 1.2 per cent. What does that mean. What is the quarterly figure. How is it gauged.

Ian Verrender: Yeah that’s correct. Now the quarterly figure here that you just mentioned, the 1.2 per cent that measures the lift in inflation from the previous quarter to this quarter now. So from the June quarter to the September quarter, over that three month period, you know, it is an increase from the from what was the previous quarter’s numbers, but it was only slightly more than was expected. And there’s a couple of reasonable excuses as to why that happened. And all of it is out of the control of consumers. You know, when you think about what the reserve Bank is trying to do and how inflation comes about, there’s two main mechanisms. One is that inflation being driven by consumer demand, you know, we’ve all got too much money in our pocket and we’re all throwing that money to chase, you know, scarce goods and services. And so we pay more and more and more. So that’s demand driven inflation. And that’s the kind of normal inflationary outbreak you get. The other kind is when you get a supply shock and suddenly there’s a shortage of something. And so the prices all rise. But it’s completely out of control of consumers.

Sam Hawley: So bring in petrol.

Ian Verrender: Yeah. And that’s what the problem is here. Now petrol prices rose 7.2 per cent during during this quarter. So that’s a really huge component in it. There was a couple of other things too. Rents continue to be a major problem. And also you know, you’ve also got things like electricity again completely out of the control of consumers. You know, you have no option but to pay for this stuff.

Sam Hawley: Yeah. It’s not discretionary.

Ian Verrender: No, not at all. The inflation isn’t being driven by by us paying for things and throwing our money around. It’s worth being forced to do it.

Sam Hawley: Yeah. And these figures, they don’t even take into account the Gaza-Israel war yet, do they?

Ian Verrender: They don’t, no.

Sam Hawley: From what you read that’s going to mean fuel prices will go up again.

Ian Verrender: They could look in the last few days they’ve actually started to drop away quite a bit. It all, you know, who knows what’s going to happen there. But it could result in a wider conflict within the region. And if that does happen, it’s highly likely that we will see another increase in fuel prices.

Sam Hawley: These inflation figures. Let’s go back to that annual inflation figure of 5.4 per cent. It still means we’re not getting much bang for our buck right now, doesn’t it? We’re paying a lot and not getting that much in our trolley.

Ian Verrender: That’s right. And you know, you consider that that wage growth is still well below that inflation growth. So in real terms everybody is taking a hit. So we’ve got less buying power. People are struggling. And on top of that to kerb demand to try and bring demand back into line with this reduced supply of things. The interest rate hikes that we’ve seen since then to do that have added to the pain. So you’ve got a quite a large portion of Australian households now doing it extraordinarily tough.

Sam Hawley: All right, Ian, let’s look further at that. At interest rates, the reserve Bank board wants inflation. We’re told over and over again to go back to that target range of 2 to 3 per cent by 2025. So we’ve still got some way to go. Michele Bullock, the head of the RBA’s, been talking about the board’s low tolerance for inflation staying higher for longer than that. She was speaking again this week wasn’t she.

Ian Verrender: She was. Yeah. It was her first official speech actually as as reserve Bank governor.

Michele Bullock, RBA Governor: The board has been clear that it has a low tolerance for allowing inflation to return to target more slowly than currently expected. Accepting this would risk eroding public credibility in our commitment to low and stable inflation.

Ian Verrender: But bear in mind that central bankers, they have two weapons at their disposal. One is interest rates, moving them to try and either make the economy speed up or slow down. And the other is talking. So when you start to run out of wriggle room on the on the actual interest rates, they usually start to ramp up the speaking and, and the threats. So she’s making it absolutely clear to everybody out there that they will raise interest rates if they have to do so. And she’ll say it as often and as loudly as possible.

Sam Hawley: Okay, but does it mean she’s going to do it?

Ian Verrender: Not necessarily. Because, you know, we’ve had 12 rate hikes now in the space of what, 18 months or so. That’s an incredibly fast pace of interest rate hikes. And when you when you’ve done so much work, when you get to that towards that peak level, the chances of making a mistake increase dramatically. I mean, exponentially. In fact.

Sam Hawley: Some economists, Ian, think on Melbourne Cup day, the RBA will raise rates again.

Economist (news clip): There is still the risk of another rate rise from here. But I think if we do get one it will just be one more.

Economist (news clip): You know unfortunately I think if they go once they’re more than likely going to go twice because one move is really just fine tuning. If they’re genuinely concerned about what’s going on, we’re probably in for a couple of hikes.

Economist (news clip): My big concern remains that the reserve Bank will end up going too far, and we’ll end up with a recession next year, and that would be a recession. We don’t need to have.

Sam Hawley: The decision for the RBA board. It’s going to be somewhat tricky.

Ian Verrender: It’s not going to be an easy decision at all. I mean, they have been making the threats and I guess if you want to continue to make threats and have people listen to you, you do occasionally have to act. But the general consensus out there is that they have one more interest rate shot left in the gun. So you’ve got to really pick the moment to fire it. I’m not sure that these figures are enough to tip the balance there. And, you know, there’s been some really interesting analysis in the past week or two, particularly from Shane Oliver from AMP capital. And he made the point that, okay, let’s say we do get a wider conflict in the Middle East. Let’s say fuel prices do rise dramatically as a result of that. Does that really mean we’ve got an inflation problem. Because what he’s arguing that it could actually be deflationary because, you know, let’s say petrol prices were all paying, say, $12 a week more than we were. He’s arguing, well, that’s $12 less that already stretched household budgets are going to have to stop spending elsewhere, which is deflationary. And these are the kind of arguments, I think, that will probably reverberate around the reserve Bank board table when they do sit down on Melbourne Cup day.

Sam Hawley: And as you say, the RBA could what, make a mistake if it does go too far, what happens?

Ian Verrender: I guess the chance of tipping the economy into a recession and then you don’t really have an inflation problem, you’ve got an unemployment problem. But, you know, this is a really strange period that we’re going through at the moment because, you know, the jobs numbers we came that we reported last week came in at 3.6%. I mean, that’s just unheard of after such a dramatic lift in interest rates, the kind that we’ve seen at least. And also given that we’ve had such a massive amount of immigration during this period as well. So, you know, to have such an extraordinarily low rate of unemployment, it’s a great thing. It’s also quite perplexing for that to be happening. It’s one factor, I guess, that is saving the economy from really tipping over at the moment, because while people remain in jobs, as difficult as it is, it may be to pay the bills and to pay the mortgage while they remain in jobs. They will do everything they can to keep a roof over their heads. It’s when unemployment starts to rise that things get really, really quite tricky.

Sam Hawley: And as you pointed to before, there’s a lot of households that are already really struggling.

Ian Verrender: Yeah. That’s right. I mean, I think there’s something around about 10 to 15 per cent of Australian households that are under mortgage stress at the moment. And when we talk about mortgage stress, we’re talking about really not having enough money to keep your head above water. You know, once you pay the mortgage and the other bills that you have to pay, there’s nothing left over and people are being forced to cut back on their spending quite dramatically. And we’re seeing that in retail sales figures. We’re seeing that right across the economy. And we’re also seeing when we talk about fuel prices being an inflationary factor, there’s a lot of companies out there who are basically saying we can’t pass on these costs because we know people can’t afford to buy. If we pass the costs on, they won’t buy our product. And, you know, pretty much everything involves fuel. And so to a large extent, businesses are starting to absorb some of those costs. That means lower profits for them. That means if that really, you know, proceeds, they might have to start laying off workers. But, you know, there’s a couple of other things that it came out in these numbers, too. And one is the extent to which the government’s assistance is actually starting to to work. And on power bills, when you talk about electricity, you know, we’ve we saw dramatic increases in electricity bills because of the fuel crisis and the energy crisis that took place after the Ukraine invasion. Those forces are actually starting to dissipate. Electricity prices, wholesale electricity prices are coming down. So again, these are the the forward looking things that the reserve Bank will be looking at when it meets on Melbourne Cup day, rather than the backward looking figures that these Bureau of Statistics numbers represent.

Sam Hawley: Um, but also, I guess it’s dealing with all the uncertainty that comes with the new war, the Israel-Gaza war. Yeah, absolutely. It sounds like it’s all a bit of a gamble. Ian, the RBA wants to bring inflation under control, but it does need to make sure it doesn’t push us into a recession. So what do you think. What’s it going to do next week?

Ian Verrender: My personal view is that this isn’t really a compelling enough argument to put rates up again, and I think you’d need to see some sort of consumer led outbreak of spending for them to do that. Essentially what we’re seeing here is price rises being forced upon the community that is flowing through the economy. And I think they’re very mindful of the amount of pain that they’ve already inflicted on, on a great number of households. I can’t see that this is compelling enough reason to do it. But, you know, I could be completely wrong.

Sam Hawley: Well, let’s hope you’re not. Many thanks, Ian. Thanks, Sam. Ian Verrender is the ABC’s business editor. If the reserve Bank does increase rates by a quarter of a percentage point, it would take the cash rate to 4.35 per cent. Rental prices have increased by 7.6 per cent annually, the largest rise since 2009. It was produced by Bridget Fitzgerald, Nell Whitehead, Anna John and Sam Dunn, who also did the mix. Our supervising producer is David Coady. I’m Sam Hawley. ABC News Daily will be back again tomorrow. Thanks for listening.