The inflation data were hot last week, but that’s not exactly the point.
So inflation has caused a bit of panic in markets and the media.
This is your quarterly reminder from Uncle Jon to chill the hell down everybody.
Yes, the inflation data came in much hotter than expected.
It was up 2.1% in the quarter, smashing expectations for a 1.7% rise. That gave us a headline annual inflation figure of 5.1%, well ahead of expectations for a 4.6%.
At 5.1%, this is the highest rate of inflation since 2000, but that 2000 number was driven by the introduction of the GST, so this is one for the history books.
So look, no denying that the inflation data is hot.
But that’s also not surprising. At 5.1%, that still puts us a fair way behind the US, the UK and even New Zealand. So we were always heading this way. We just got there a few months quicker than expected.
And when you break it down, the drivers of inflation aren’t a surprise. Transport is the big one, with that component running at a massive 13% year on year. The other big one is housing costs, running at 6.7%.
Now this is the central point. Both of these two measures are really stories about supply shocks.
Transport is driven by the spike in fuel prices, which is all thanks to the war in Ukraine.
Housing costs are driven by a material shortage that’s hammering the building industry right now.
So these things are all about supply shocks.
Why does that matter?
Well there’s a big difference between inflation that comes out of supply shocks compared with inflation that comes out of demand shocks.
Supply shocks tend to be more temporary (or ‘transitory’ in the language of central bankers), while demand shocks are more likely to be permanent.
And why does that matter?
Well, if it’s temporary, then there isn’t all that much point rolling out the rate hike guns to fight it. If the RBA lifts rates that will have precisely zero impact on global oil prices anyway.
Indeed, oil prices have already turned deflationary. Remember for inflation to keep rising, prices need to keep going up. If they go up and then stop, then inflation drops to zero.
So oil prices have already come a long way off their recent highs, and are therefore going to start putting downward pressure on the inflation rate.
Similar story with building costs. Material prices have become expensive, but are they going to keep on getting more expensive?
And this is what the RBA will be mulling up. If inflation is all about transitory supply shocks, then there’s not all that much need to jack up interest rates.
So personally, I expect they’ll hold fire today, although I’m not high conviction on that.
And while I’m certain we’ll get a rate hike in June either way, I still don’t see the case for an aggressive rate hike cycle.
I know markets are pricing it in, especially after last week’s inflation numbers, but I still don’t see the argument.
Rates will ‘normalise’ from their history lows, but I don’t expect them to go all that much higher from there.