Dear RBA, DO NOT HIKE INTEREST RATES

We’ll get the inflation number today and it’ll blow out. The central bank should look straight through it. Why? 

Because there is a mounting deflationary shock globally as Europe is rocked by a war and energy shock. China is rocked by a property and COVID shock. And the US is rocked by an inflation and interest rate shock.

A global recession is on the way and it will automatically deflate prices, probably sending them deeply negative in 2023 in a rerun of what happened in the post-Spanish Fly great deflation of 1920/21.  Equity markets are beginning to price this, and it is coming faster than anybody realises.

If this is the case, then there is no commodities investment boom coming to Australia. There is already enough embedded tightening in the fixed interest rate reset to sink house prices 10%. And the RBA should rather be worried about the unwind of pandemic distortions as supply-side strains collapse into excess. 

Australia is lagging this global cycle by a quarter or two so we have the good fortune of not having to repeat others’ mistakes. 

Below find UBS on how this playing out in the US even before we see Fed hikes which are coming fast to crash the lot.

For several months, media reports have been breathlessly(and repeatedly) reporting that the latest developed economy consumer price inflation data is the highest in decades. As the trend in the year on year rate of inflation has been rising, stories can be recycled month after month, because inflation has always proved to be higher. Economists, however, see inflation as falling over the second half of this year – the peaks in consumer price inflation will take place at different times in different economies, but the trend of falling inflation is a high conviction call. There are three reasons for economists to be confident.

(Some) Prices are already falling

The inflation story last year was simple. In developed economies there was an extraordinary surge in demand for goods – in the US, demand for durable goods surged in away not seen since the ending of wartime rationing in 1946. Consumers had fiscally supported incomes when lockdowns prevented spending – and as restrictions lifted they rushed to spend. Supply also surged, but as the supply surge could not keep up with the demand surge there was an imbalance. The result was a mix of shortages, and price inflation.

Economists knew that the pandemic savings could not last and thus the demand surge could not last, which was why the inflation was labeled transitory. And, indeed, the demand surge has not lasted (fading first in the US, and later elsewhere). The related inflation has proved to be transitory. The supply-demand imbalance has shrunk, and in some areas markets may even have to consider excess supply at some point. The result is that inflation rates for products affected by the supply demand imbalance are starting to fall as demand slows. For some products, inflation is turninginto outright deflation.

Lower inflation and outright deflation in developed economies can be seen in exactly the areas where demand soared and then fell. Used cars and televisions saw unusual increases in prices last year, and now prices are tumbling.

Inflation can also be self-destructive – higher prices reduce demand, leading to lower prices. US households have been paying higher prices for fuel recently, meaning that they have less money to spend on other items. Lower income households in particular have had to cut back on other spending, and this slowdown in demand is relevant for non-fuel prices. Thus, in March prices in US fast food restaurants had their biggest monthly drop in twenty years (although prices are still higher than a year ago).

Base effects start comparing normal to normal

It is always worth remembering that inflation is all about the change in prices – and so a year on year inflation rate tells us something about price pressures today, but also about price pressures a year ago.

During the first quarter of 2022, the year on year inflation rate was comparing a normal economy (more or less) with the lockdown economy of first quarter 2021. Inevitably moving from “lockdown” to “normal” will involve a large price change. As we move through the second quarter, the comparison will change. First we will be comparing normal in 2022 with reopening in 2021. Later, we will be comparing normal in 2022 with normal in 2021. By the time the comparison is “normal” to “normal” the price change should be quite muted.

Prices normally go up – falling prices are relatively unusual. If prices go up more quickly, inflation rates (the change in prices) will rise. If prices go up more slowly, inflation rates will slow. Thus higher oil prices this year are likely to lower the rate of inflation. In the year to March 2022 crude oil prices rose 77%, driving up headline inflation. As long as oil price srise less than 77% over the next 12 months (meaning a Brent crude oil price level below USD205), oil will contribute less to the future rate of headline inflation.

Wage costs are not spiraling

Labour costs are the largest component of an inflation basket. In developed economies the processing, packaging, distribution and advertising of everything we buy uses enormous amounts of labour. If labour costs are rising at a faster and faster pace, it will be difficult for inflation to fall.

Wages are not the same as labour costs. If people are working harder, they can be paid more without causing inflation. And that is what is happening.

Across many developed economies, economic output (GDP)is near or above the pre-pandemic level. But employment is below pre-pandemic levels. In other words, fewer people are working harder to produce more stuff. Paying fewer people higher wages if they are doing more does not raise wage costs.

It is also important to distinguish between one off corrections in wage costs, and a continuous increase in wages. For instance, the increase in demand for goods(rather than services) and the rising share of online retail increased demand for delivery drivers. When there is a shock increase in demand for labour, wages will rise until enough people are attracted to the jobs. This is one reason why wages for delivery drivers rose. However, once wages are high enough to attract sufficient workers, there is no need for wages to keep rising at the same pace – a one off shock increase in demand is met with a one of shock increase in wage costs, and then more normal behaviour.

Inflation to fall

The pandemic was an extraordinary economic shock, as was the scale of the policy response. It has produced extraordinary inflation in consequence. Indeed, given the pent-up demand created by pandemic-related limits on spending and exceptional income support, one of the biggest surprises is perhaps that inflation has been as modest as it has.

As the world moves further and further away from the pandemic, it moves further and further away from the extraordinary economic consequences. Demand is normalising, and companies that had pricing power when demand was unimaginably high are finding that they do not have the same pricing power now demand is low. We have been looking at past prices as much as current prices- with the year on year comparisons forcing us to look back to lockdowns. In the coming quarter we will finally leave lockdowns behind us as the backward looking comparisons will come to an end. And finally, there is no evidence of the second round effects of inflation emerging – a wage cost / price spiral (which would be a very troubling signal for inflation) is notably absent.

Economists are rightly confident in the view that inflation is going to fall.

What is less certain is how low inflation will go.

Houses and Holes
Latest posts by Houses and Holes (see all)

Comments

    • Used Car sales, who cares, food is up

      Notable prices rises were recorded across the food group in March quarter (up 2.8 per cent), reflecting high transport, fertiliser, packaging and ingredient costs, as well as Covid-related disruptions and herd restocking due to favourable weather.

      Main contributors to the rise in food prices included vegetables (up 6.6 per cent), waters, soft drinks and juices (up 5.6 per cent), fruit (up 4.9 per cent) and beef (up 7.6 per cent).

      • C.M.BurnsMEMBER

        exactly. the price increases are across the board in all inelastic goods. No one cares of the price of a 2nd hand car, or a tv both start to decline, if they are paying so much more for all the basics.

  1. Goldstandard1MEMBER

    Sorry mate, we fundamentally disagree on this one. We have to have the chickens come home to roost with interest rates at a NORMAL neutral level. That is cash rate at 2.5%. Your advice is to stay at emergency levels which is not teaching anyone anything.

    Your quote of house prices falling 10% is nothing considering they grew 20% last year, so prices actually need to fall that far plus another 30%. Shares the same. Debt is far too high, people’s risk appetites are far to high and need to get flushed.

    The bubble must burst and serve as a warning for ppl leveraging INTO crisis. We must flush this debt level and houses and businesses must be lost in the process and build from that level again.

    • happy valleyMEMBER

      “That is cash rate at 2.5%”

      Of the 2.4% increase to that, the private banksters will pocket at least 2.0% to send their NIM and bonuses to the moon?

      • We are currently at 5.1% qtrly inflation. Mortgage debt on variable rates is 2.5%. Effective interest rate of -2.6%. Rates need to go up by that much to be neutral (today). Its not about today though, its what it will be in the coming 3-12 months. RBA will be nervous raising into a collapsing global economy as it amplifies the shock on households.

        Lots of crystal balls and cristal champage in their future me thinks.

        • The figures are true but I think this time is different, ie most of that inflation really is transitory, admittedly a sort of constipated transitory inflation, supply side type, that is a danger it becomes more permanent & demand side, but they say so far this is not showing up in Australian wage rises (thanks to LNP weakening labour rights?) so we hopefully have time as the rest of the worlds inflation falls as commodities bust. Europe won’t be able to export their energy inflation then, I’d say, or China as when demand drops prices are lowered. For the moment people will just have to wear this inflation and if they are lucky and there really is some deflation coming next year …
          But you could be right, most people would agree with you, I think.
          (Our huge debt levels cannot handle rates rising that extra 2.4% or thereabouts.)

    • I agree, can MB provide a solution other than interest rates should remain next to zero, as that has not worked. Inflation is real and is not going away, the cost of living has exploded, whether that is reflected in the official inflation figure might not be the case. Housing costs are out of control and debt levels are rediculous.
      Time we had a flood, as to speak, and flushed out the system. Sick of a world where everyone can be reckless and expects the govnuts to bail them out.
      Mortgage holders are not the only people in our society, savers and pensioners should also be considered.

    • The fed broke it. Now, they own it.

      I agree. Look at Perth. Record low interest rates, record low rental vacancy and the cheapest houses in Australia but no boom. Why? Because people are so scarred by previous busts no one wants to go through negative equity again.

    • Diogenes the CynicMEMBER

      I’m with you Goldstandard1 time to raise rates. People will never learn until they burn their hands. Besides if we don’t then Aus faces the Sunlord’s scenario where RBA have lost control and must raise rates or inflation goes to double digits as the currency plummets. Housing prices need to fall.

      • “RBA…must raise rates”?

        They are a sovereign currency issuer, they can do whatever they want with the rates.

        • Not exactly, they have to turn up at the auction and print $$ and be the buyer of last resort to be afforded the privilege of “doing what they want”. They set the rate target and then have to madly 3print to buy enough bonds to maintain the rate at the target.
          They suddenly got shy last Nov and chose not to do that
          The currency will keep copping it until they either raise rates or stick to their IR target by bond buying.
          No free lunch.

          • Agree but we all know printed money is not real money, as a currency issuer its just numbers on a balance sheet. The other counterpoint is that they got shy prior because there was no trigger to fight the market, consumers were fat and happy. Throw in a country of citizens in financial distress and you will see what they are made of.

            i.e. Mum and dad being evicted from their home or print fake money like crazy and smash the currency (great for exporters). Hard to do it forever but sure as sh!t they can do it for a while.

        • Sure but there is no trigger right now either. Consumers are fat and happy according to those inflation numbers. Who’s got 5% more $$ to pay for prices? Apparently everyone.
          Proofs in the pudding right. Markets predicted a rate hike this year long before rba stopped yapping “patient”. Have they been “doing what they want” or following the market so far?? That trigger of pain hasn’t been breached so far so get on getting on then.

      • Mmmm I haven’t really considered the inflation in Aus as AUD tanks, question of how far CNY tanks at the same time?

  2. Can we have a little rise, just to 0.5? Wouldn’t keeping current rates still be pushing us in wrong direction for rest of year? Or is even that above the “neutral” rate?

  3. They have to go up slightly anyway (probably to 1.5% OCR eventually). Might as well start doing it during an election campaign – watching Joshy blame it on the ALP will be fun.

  4. Ronin8317MEMBER

    Australia have below 4% unemployment and 5% inflation. If the RBA don’t hike rates, what’s the point of having a Central Bank at all?

    In modern times, no country can break the nexus between inflation and interest rate. It has become dogma, and any country that goes against dogma will be punished by the unholy wrath of the market.

    • happy valleyMEMBER

      The RBA is a sheltered workshop and only exists to ensure that house prices are forever increasing … bigly.

  5. I agree with everything but the conclusion. There may never be a better time to normalise. There is a huge amount of liquidity in the private sector, both in Aus and US. That means if there is a recession it will be short and sharp but as a result we will have reset rates to slightly less stupid levels. The inflation narrative is obviously BS but it’s really just a pretense for normalising policy. And that’s a good thing.

  6. C.M.BurnsMEMBER

    inflation anecdata from a friend: the cost of shipping from China to Australia has increased approx 350% from before covid. From ~ $7k a container to ~ $25k a container. And he can’t see any sign of this reversing in the short or even medium term.

    And that doens’t even account for the inflation on the goods within the container.

    Nor the inflation in the services (and the inputs to those services, like fuel costs) here in Australia.v

    Inflation is here to stay (disagree with you bigly on this Dave, and also the call not to raise rates).

  7. Your prescription for everything is looser Monetary Policy. You are viewing this situation through the lens of your own entrenched thinking. Not that the RBA will pay any attention because it can’t. It has to pursue its responsibilities under the RBA act.
    Don’t destroy your credibility over this call. You guys have worked much too hard.

  8. One trick ponyMEMBER

    A lot of people on here focusing only on what should happen rather than what will happen – “the bubble must bust, financial cleanout, teach those over leveraged punters a lesson” etc – Theoretically I actually agree with a lot of that, but it doesn’t matter. The only thing that matters is what the RBA will actually do, and I don’t think a financial cleanout is on Lowe’s agenda (which isn’t to say it won’t happen, but if it does – Lowe won’t make it worse with more rate rises).

    • working class hamMEMBER

      Pony for the win.
      What is a logical response and what will happen diverged decades ago, with all reason being decimated with the CV19 response.
      Interest rate hikes are used to slow spending? Causing deflation/recession?
      What if the threat of interest rates and recession was enough to cause a recession/deflation without the obscene hikes already priced in by 3-5 yr fixed rates?
      Can we get the same results without the real pain? Can the over leveraged masses be swayed by MSM enough to stop spending?
      Almost a decade of the LNP shows me that the Australian public can be convinced of anything with enough airtime.

    • Actually I can see bcnichs prediction coming true where this lot is hauled into a royal commission and asked to explain what happened. And the question will be asked “when the data became available why didn’t you act?”

      If I was the governor who’s 2ic just quit 2 months ago and that RC witness box is looking quite lonely right about now, am I going to follow the book so one day I can point them out on paper at the stand? or would i go out on a limb and NOT raise rates when the data is screaming so?
      Forget about the fact that we are headed for a crash regardless, “naking it a little bad or worse” isn’t the barometer here, it is, “which action is better explainable on the stand? why would I put my neck on the line like that?

      • Very much agree with this, Captain Phil has pointedly said on a number of occasions that house prices are not the RBA s remit,
        No one believes him but also nice bit of smoke cover on the stand.
        It occurs to me that immediately launching into a rate hiking cycle when/if a labor government takes office for the first time in 9 years will potentially get the RBA very off side with that side of politics, regardless of intention its a very bad look.
        Its not like an aus politician to be petty and vengeful…An enquiry , a royal commision even what do we do with our new fed icac

  9. ‘Australia is lagging this global cycle by a quarter or two so we have the good fortune of not having to repeat others’ mistakes.’

    So glad we didn’t follow them into an unsustainable asset price bubble, that would have been devastating.

  10. Underlying deflation will only stop when the wealth divide stops growing. Until then it will be papered over with printing. When this printing has been over the top, like the last couple years, we will hit these short term inflationary spikes. These spikes will be stopped with a central bank response. Which will then need to be reversed (more printing) when the actual underlying deflation is exposed once again. For over 50 years now labour has been losing wealth to the capital owners. Solve that, and underlying deflation will vanish, along with the money printing that is required to constantly paper over it. So raise rates or don’t, nothing will be solved either way.

    • Agree, rates are kinda useless. In the next crisis, don’t do QE. Let the cards fall where they may. Assets (owned by the rich) have only gone up because the rich have access to cheap money supplies created by CB’s printing. MMT I see slightly differently as this is money to main street, not wall st.

  11. Sorry but what are you guys smoking? All this means is that they were way too late and now it is too late to do anything, so don’t do anything??
    And have you forgotten that these people are more interested in covering their arses than your investment thesis? They will raise to make it look like they tried to do something.

    • The Travelling PhantomMEMBER

      Exactly, just to match DLS investment thesis the RBA should not lift the interest rate

    • Jumping jack flash

      Yes but this was the banks’ economic utopia. An entirely new paradigm that was thought up way back yonder and implemented decisively at the command of Bush. Who was Greenspan to argue? With one stroke of a pen he cemented the banks’ control over everything.

      As soon as interest rates were artificially lowered, the new wave of false demand caused by the spending of that debt (and the subsequent jobs and wages born from it) ensured that the banks would from that point have total control over the economy through their debt and the spending of it.

      It seems a shame that they grow tired of it now because it isn’t working out for them. They need to see it through!

      Or perhaps the banks themselves can take the hit from their poor decision and leave us alone? No, I didn’t think so.

  12. Glad MacroBusiness are not running the RBA! Sometimes I wonder though if Phil Lowe gets confirmation bias from reading their uber dovish musings.

  13. Usual loaf of Tiptop bread was up 8% at Coles yesterday.

    Had seen no price change in the previous 3 years.

    Interest rates need to rise so my bread doesn’t.

  14. What more interesting about the current economic inflation numbers: Lower inflation is better for the average person than higher inflation, since even in sunshine times (border closures, low unemployment, emergency IR’s) there’s no longer any real mechanism for wages to rise to follow suit. Higher inflation means lower purchasing power for the majority of people – an IR raise if it lowers inflation is effectively a real payrise for many people especially the non-mortgaged.

    What’s interesting about this inflation period is what it shows. Wages, and any transmission mechanism to make them rise (border closures, inflation expectations, etc) are not really enough to raise wages substantially. Big business and government have removed most transmission mechanisms that would allow workers to gain a raise as a result of inflation. One by one over the past 20 years any transmission mechanism to flow to wage rises has been systematically removed by government.

    Any waiting on wages to rise to raise the rates will impoverish people even more as inflation overtakes any wage rises due to current settings. Real wages are falling fast due to inflation way before we see nominal rises. I know non-political, non-economic people even saying they need to raise the rates now which is usually a very unpopular move.

    • So true about the transmission mechanisms. Ironically it might actually save us in the short term and ensure this inflation really is transitory, long term it’s will mean we slide down the pecking order.

      • Jumping jack flash

        The pecking order may be malleable, but the amounts of debt people owe to the banks is not.

        • And of course inflation eats into their ability to pay the mortgage but not as much as an interest rate rise. In the end do you favour mortgage holders at the expense of everyone, or do you take the broader cost of living of most people into account? Its a hard decision.

    • This is correct!! Good point well made.
      The transmission mechanisms for higher wages are broken.
      I will add though, on the other hand,the transmission mechanisms for higher prices are very much intact. I.e. the globalisation of the workforce acts against higher wages,and globalisation of the supply chains acts FOR inflationary pressures if the supply chain is broken.

      For last few decades, these two have been in sync. I.e.the increasingly global supply chainhas allowed for deflation in goods whilst globalisation in labour has decreased the rate of wage rises. This is not as much a problem, you spend less but also earn less.
      Now, the supply chains are working against you in disruptions causing inflation, you need the transmission mechanisms for higher wages to kick in. And they are broken.

      • Yep. Lots of ideology, offshoring, immigration, etc. Bonuses and such have risen rather than permanent wage increases, mainly because many employers were hoping post-pandemic more workers would become available.

        An individual worker really has no power, and hardly any information compared to employers (who often share each others wage figures and act in a cartel like fashion) to pressure for price rises.

        Inflation results in a loss of purchasing power, either for the employer or the employee depending who has the weaker hand. It was at one point the employer, now it is the employee.

  15. Jumping jack flash

    The correction was well underway, naturally, by the end of 2019. Well-established businesses were going broke all over the place because of debt saturation not causing the correct rate of debt expansion to maintain levels of fake debt-demand.

    Interest rates had effectively bottomed out, and the governments were resorting to financial shenanigans to effectively bribe the banks to lower interest rates beyond what any of the banks were comfortable with.

    2020 juiced it big time and caused the inflation we see now. I personally thought that it was/is an attempt to fix the broken debt economy with inflation. Goodness knows we need it now. And perhaps some of our banking overlords intended that to be the case…

    However, others of our financial overlords either don’t see or don’t want to see our debt economy for what it actually is – an unproductive false economy that is a function of debt expansion created by lowering interest rates. These stalwarts of economic “prudence” recoil in horror at the prospect of inflating wages and want to step on its neck. Indeed if our economy was a traditional economy then maybe they are justified, but it is not and certainly hasn’t been for close to a generation.

    Are they unaware, or simply ignore the facts that inflating wages are now required to maintain the correct rates of debt expansion, to maintain the levels of false demand that power our false consumer economy, now that interest rates have bottomed out?

    Do they realise that as soon as incomes start inflating sufficiently then they can raise interest rates by tiny amounts at a time to give the guise of a properly functioning economy?

    Perhaps, sitting in their ivory towers, they imagine that if they stop debt expansion to create the fake demand that is responsible for keeping us employed and paid, that somehow, magically, all these new productive factories will spring up and start employing everyone to create useful items for selling to the world for profit?

  16. John Howards Bowling Coach

    They probably have to raise rate now. Inflation is massive right now and hopefully prices will ease but so far it isn’t really happening, just a lot of searching to try to uncover some price falls.

    The property issue here is hard to break though. Aussies are stupid to the extreme and given a $1 in their offset they will rush to the nearest broker to loan a $trillion more debt to buy another investment property. Look at what happened during the lockdowns and pandemic. People by the 1000s took their handouts and sent the price of real estate even further into the stratosphere. We probably need a proper recession and collapse here to teach the majority of Australia that they are moronic lemmings and just because a property agent told them it was ‘good debt’ they still need to pay it back.

    • Are they silly for doing so? Many people who did just that are retiring early and/or much wealthier than otherwise. They are just playing the system that they’ve been dealt. Given the government(s) have actually encouraged this maybe its been instead dumb to go against the system? That is until inflation catches up (i.e. now).

  17. High oil and gas prices were baked in BEFORE the ukraine war…5 years of below replacement investment. The disruptions to oil and gas supplies from Russia are likely to continue for years this will bring inflation in the great majority of goods and services,
    There will be no wage inflation with our current immigration settings regardless of who wins the next election (importing nurses, not paying current residents more etc.) as DLS well knows,
    So what you are in effect calling for Mr Smith, is continued inflation in asset prices while wage earners go backwards.
    What has ZIRP gained us in any tangible form?

  18. reusachtigeMEMBER

    Yeah bloke, you’re ace as at protecting housing investments. Lower teh interest rates, that will fix thing!