Inflation is here to stay. Here’s why.

Last week’s CPI print from the Reserve Bank of Australia (RBA) revealed a 5.1% increase, well above the central bank’s target band of 2-3%.

The increase had been anticipated by the market given the flurry of quarterly updates by ASX during April highlighted inflation across various sectors with no clear end in sight:

• Audinate, the global leader in audio networking solutions to original equipment manufacturers, passed through a 25% increase in its flagship Brookyn and Broadway products. The company says gross margins remain stable for now, but will likely deteriorate as spot inventory purchases flow through. 
• BHP noted in its quarterly update that pandemic induced absences led to the miner producing negative growth across its commodity portfolio. CEO Mike Henry also called worker shortages a key chokepoint, which is unlikely to abate anytime soon.
• Coles revealed that food inflation had reached 3.3% in the March quarter, a reversal from deflation of 0.2% in the December quarter. Management noted inflation pressure from suppliers is only increasing, with further suppliers pushing for more price increases.

The RBA isn’t getting any help from the folks in Canberra either. On Thursday the coalition handed out $250 cost of living payments for 6 million pension and welfare recipients. On July, 10 million Australians will also receive a new, one-off $420 cost of living tax offset. And they are supposed to be the better economic managers!

Subsequently, Governor Phillip Lowe is under increasing pressure to lift the cash rate off emergency lows and towards a more normalised level to tame aggregate demand.

A growing tango line of economists is now predicting a rate rise in May including ANZ, Westpac, NAB, UBS, Barrenjoey, JPMorgan, RBC Capital Markets, Barclays, Deutsche Bank and AMP.

But it’s a delicate balancing act. Raising too fast – as the RBA has warned against previously – could place unnecessary pressure on households and businesses forcing Australia into a recession.

If the RBA raises rates to 2.50% – what the bond market is currently pricing by the end of the year. – that alone would add $680 in extra repayments per month to a typical $500,000 principal and interest mortgage with 25 years remaining.

Complicating the situation, a May raise would be the first time the cash rate has increased in 12 years and coincide with votes going to the polls on May 21, throwing fuel on an already intense political battleground of cost of living.

Lowe has proven himself to be a patient operator in the past, previously stating the RBA was willing to temporarily tolerate inflation above its target range until stronger evidence of wage growth emerged. Therefore he will want to wait for further wage data later in May and earnings data in June before diving Australia headfirst into a tightening cycle.

But the CPI, company updates and government handouts clearly demonstrate that the RBA needs to act urgently. Inflation is banging down the door. Unfortunately, the RBA’s conservative approach will make sure it’s here to stay.

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Lachlan Buur-Jensen

Lachlan is an experienced journalist writing across The Inside Investor and The Inside Adviser.