Investors now believe there is a one-in-three chance of an August interest rate rise after inflation surged to its highest rate in six months in May. Economists have warned that underlying price pressures remain too strong.
According to the Australian Bureau of Statistics, annual inflation rose to 4% in May, up from 3.6% in April. This outcome exceeded market expectations, which anticipated inflation to increase to 3.8%.
The sharp increase in inflation was driven by significant annual rises in the cost of fruit and vegetables, as well as increases in the prices of alcohol, clothes, and electricity.
RBA’s Response to Inflation Data
Speaking before the release of the data, RBA assistant governor Christopher Kent acknowledged that recent data had been “mixed” and “reinforced the need to remain vigilant to upside risks to inflation”.
While the monthly consumer price index is volatile, the figures highlighted the persistence of Australia’s inflation outbreak. Headline inflation is running at its fastest rate since November, while underlying inflation has remained around 4% since December.
Rate Rise Bets Increase
Economists agree that the RBA’s August 6 meeting is “live.” Following the release of the CPI data, investors increased their bets on a rate rise, now pricing in a one-in-three chance that the RBA board will raise the cash rate to 4.6% from 4.35% in August, up from a 13% chance on Tuesday.
June Quarter CPI Figures Crucial for RBA’s Decision on Rate Hike
The June quarter consumer price index (CPI) figures, due on July 31, will be pivotal in aiding the Reserve Bank of Australia (RBA) in determining if inflation is on track to return to target levels.
Deutsche Bank’s chief economist, Phil O’Donaghoe, now anticipates the RBA will increase the cash rate to 4.6% in August, abandoning his earlier prediction for a November rate cut. O’Donaghoe stated, “Underlying inflation is intolerably high in Australia. In fact, Australia is the only G10 country where underlying inflation has increased since December.”
Betashares’ chief economist, David Bassanese, described the inflation figures as a “shocker” and noted that they put “huge pressure on the Reserve Bank to raise interest rates in August.” Bassanese added, “Stepping back from the month-to-month noise, one clear disappointing signal emerges – annual inflation across various measures has failed to decline much further in 2024 and remains ‘stuck’ at an uncomfortably high level of around 4 per cent.”
Inflation Exceeds RBA Forecasts
Wednesday’s figures indicate that inflation is outpacing the RBA’s forecast for underlying inflation to ease to 3.8% in the June quarter. Excluding holiday travel and volatile items like fruit and fuel, inflation slightly decreased to 4% in May from 4.1% in April. However, trimmed mean inflation rose to 4.4% from 4.1%.
Persistent Inflation in Services Sector
A significant concern for the RBA is the persistent inflation in the labour-intensive services sector. In May, the cost of going to the vet increased by 7.1% over the previous 12 months, while the price of haircuts rose by 5.5%, and restaurant meals became 4.2% more expensive.
Industry Concerns and Government Spending
Australian Industry Group chief executive Innes Willox described the inflation figures as a “clear warning” of impending interest rate hikes. Willox emphasized the need for governmental measures to contain inflation, criticizing recent budgets for unrestrained spending that has driven up debt and deficits, particularly at the state level.
Future Outlook
Despite the recent rise in headline inflation, economists expect it to fall sharply when federal and state government electricity rebates take effect from July.
Temporary Relief from Subsidies
Commonwealth Bank economist Stephen Wu estimates that various government measures, including a $300 federal subsidy and a $1000 rebate for Queenslanders, will cause electricity prices to drop by 20% in the September quarter. This decrease is expected to subtract 0.5 percentage points from the Consumer Price Index (CPI).
While this could temporarily bring headline inflation below 3%, underlying inflation is likely to remain well above the RBA’s target band of 2 to 3%. Consequently, the prospect of a near-term rate cut remains unlikely. RBA Governor Michele Bullock has stated that the board will disregard the disinflationary impact of these temporary subsidies.
Housing Costs Remain a Major Concern
Inflation in the housing market continued to exert significant upward pressure on the CPI in May. Although rent inflation slightly decreased to 7.4% in May, it remains close to its fastest rate since 2009. This persistent rent inflation is driven by a shortage of home building and strong demand, which have pushed rental vacancy rates to record lows.
Stalled Disinflation in Home Building Costs
Disinflation in the cost of home building has stalled, maintaining an annual rate of about 5%. This stagnation is partly due to a significant pipeline of state government infrastructure projects, which are exerting upward pressure on building material and labor costs.
Tapering Goods Price Disinflation
Goods price disinflation, which contributed significantly to the fall in inflation last year, appears to be tapering off. Over the past 12 months, price rises have been observed across clothing and footwear.
Monthly CPI Indicator’s Influence
While the RBA still considers the quarterly CPI the best gauge of inflationary pressures, the new monthly indicator has become increasingly relevant. This monthly indicator factors into the central bank’s interest rate decisions, especially when it delivers unexpected outcomes.
Stay ahead of the financial curve by understanding how rising inflation and potential interest rate hikes could impact your finances. For personalized advice and strategies to manage your investments and loans during this volatile period, contact Boa & Co at 1300 952 286 or email info@boanco.com.au. Visit www.boanco.com.au for more insights and expert guidance.