The RBA is in an enviable position compared with its peers in North America, the United Kingdom and New Zealand. Australian inflation is high by our standards but comparatively low by international standards. At this stage, Australian inflation also seems less likely to become entrenched compared with inflation elsewhere. The US Fed, Bank of Canada, Bank of England and Reserve Bank of New Zealand are belatedly chasing down high inflation rates running at multiples of their respective inflation targets jumping. All have had to hike several times with the occasional 50bps rate hike thrown into the policy tightening mix.
Read economic updates from Alexander Funds' Chief Economist Stephen Roberts
Volatile financial markets in April saw risk assets mostly weaken during the month and government bond yields pushed higher. High inflation readings prompted some central banks to deliver bigger interest rate hikes and the US Fed indicated that when it meets this week it may deliver a 50bps rate hike. Rising interest rates were one factor in April adding to the risk of slowing global economic growth. Other factors were the impact of the Ukraine conflict and China’s difficulty containing Omicron. Despite the increasingly gloomy global economic growth outlook, recent economic data in the US remains strong and the likelihood that annual US inflation readings peaked in March/April and will reduce for a period. This may provide the Fed with leeway to hike interest rates at a slower pace than financial markets are expecting over the next year.
Australia’s annual CPI inflation rate is likely to peak for the current upswing with the Q1 2022 CPI report to be released on Wednesday 27th April. Annual headline CPI inflation will be around 4.5% y-o-y, comparatively low by international comparison, but well above the RBA’s 2-3% target range. Underlying annual inflation using the trimmed mean and weighted median measures are likely to push up to around 3.2% y-o-y in the Q1 report but may not peak until the Q2 or Q3 2022 reports.
Swings in economic activity over the past two years have been unusually large with most advanced economies experiencing deep recession in mid-2020 and strong growth, albeit bumpy at times, since. The global pandemic and restrictions to contain it were responsible for the deep recession and the bumpiness of the recovery since. The power behind the post-recession recovery came from a large-scale lift in government spending combined with central banks ramping up their balance sheets with bond purchases and keeping interest rates exceptionally low.
In March high inflation and what central banks might do to tackle it was the dominant theme in financial markets. Government bond markets suffered their worst month in 30 years with yields up sharply responding to fear of aggressive hikes in official interest rates by central banks. The US Federal Reserve (Fed) facing sustained high US inflation caused by strong growth stretching disrupted supply chains and showing signs of being sustained by rising wages, talked about the need for regular and bigger rate hikes. It delivered at its March policy meeting a minimal 25 basis point (bps) rate hike taking the Federal Funds up to 0.25% to 0.50% range to combat US inflation at 7.9% y-o-y in February and expected to be above 8% in March.
Global economic growth remains strong although concerns about weaker future growth are increasing with the Ukraine war adding to high inflation and central banks under increasing pressure to act more forcefully to contain inflation. Government bond yields are rising fast with bond markets starting to recognise that the prolonged period of disinflation is over, and that inflation will settle longer term at a higher annual rate than it has in recent decades at cycle low points. While business and consumer sentiment are weakening, strong past economic growth still has momentum reinforced by a build-up of household savings through the Covid pandemic that could be spent, as well as greater growth in government spending than is usual in strongly recovering economies.
The war in Ukraine has changed the outlook for economic growth and inflation. To date the escalation of hostilities in Ukraine and the escalation of economic sanctions against Russia, apart from devastating both economies, have curtailed supplies of key commodities such gas, oil, grains and nickel and lifted their prices substantially including those of near substitutes. The war has generated a major supply shock at a time when most major economies are still experiencing bunged up supply chains as well as strong demand fostered by growth in government spending, still easy monetary conditions, low unemployment rates, rising wages and elevated household wealth.
In February volatility in financial markets increased markedly as concerns about high inflation and what central banks might do about it was overlayed by a sharp increase in uncertainty, with the outbreak of a wider war in the Ukraine. Among the issues facing investors, with no clear answers, are how the war will unfold in the Ukraine, Russia, Europe and the world; the near-term impact on inflation and growth prospects; and the impact on the plans of central banks facing potential stresses on the plumbing of the global financial system while at the same time dealing with a new factor adding to inflation.