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Was team transitory right after all? Editor’s note

Lewis Jackson  |  30 Jul 2022Text size  Decrease  Increase  |  
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More topsy-turvy markets this week. Supersized rate hikes from Jay Powell triggered the best day for the tech-heavy Nasdaq in more than two years. The ASX caught some of the breeze and ended the week up 2.3%. Bad news is good news right now, but in fragile markets it won’t take much for bad news to be bad news. Disagree? Get in touch at editorialAU@morningstar.com.

Is inflation peaking?

Wednesday’s Consumer Price Index release was the most anticipated in years and has made the once-obscure work of the bureaucrats at the Australian Bureau of Statistics (ABS) fodder for everyday conversations. It did not disappoint. At 6.1%, prices rose at the fastest clip since Howard.

But amid the understandable concern were encouraging signs we may be nearing the top of the inflation wave.

Financial markets seem to think so. Bond yields in Australia are sliding as investors snap up fixed income in the expectation that central banks will wrestle inflation back into its box, perhaps via a recession. An instrument that tracks the average inflation US traders expect over the next five years peaked in March and has declined 26 % since.

Looking closely at the headline 6.1% increase, there are several reasons to think financial markets are right.

For one, many prices decelerated. Of the 11 broad categories tracked by the ABS, the pace of seven slowed in the June 2022 data, including the all-important food and housing categories, which account for nearly half the index. Big-ticket automotive fuel rose 4.2% in the June quarter, down from 11% last quarter.

It’s the same story in the finer detail. Prices decelerated across more than half the 119 subcategories, ranging from eggs to newspapers. The trend is even more pronounced in the seasonally-adjusted figures the ABS uses to smooth out predictable season fluctuations. Inflation is high and rising, but for now some of the momentum looks to be fading.

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High prices continue to be driven by idiosyncratic factors. Tradeable goods (such as petrol), rose twice as fast as non-tradeables (such as restaurant meals) due to the shortages and disruptions wracking international trade. Widespread flooding along the east coast pushed up prices for fresh produce.

But even as floods in Australia or factory closures in China trigger imbalances in supply and demand that push up prices, they’re unlikely to be self-sustaining. Flood waters recede and factory gates reopen.

Soaring wheat prices, which drove up bread and pasta prices, have almost halved since the peak immediately following Russia’s invasion of Ukraine and are near pre-invasion levels. Other commodity prices are down too. Global shipping costs have fallen roughly a third since last September.

Shocks should worry us if they lead people to expect, demand and receive pay rises which go on to fuel higher prices and further rounds of wage increases—the dreaded wage-price spiral. But wage growth remains modest and a spiral remains for the moment a “boomer fantasy.”

There was also good news on the services front. Haircuts, doctor’s appointments, cinema visits and other services are roughly half the CPI basket but only a fifth of the price rises. Of the 6.1% year-on-year inflation, “only” 1.3% was services. JP Morgan chief economist Ben Jarman says inflation would be in the Reserve Bank’s target band if goods inflation returned to normal.

Subdued services prices matter for a few reasons. Services tend to reflect local economic conditions more than goods, which are often made overseas or with imported parts. Slower price growth suggests a healthier balance between supply and demand within Australia.

Finally, the inflation numbers are unlikely to incorporate much of the tightening the Reserve Bank has engineered since April. It’s easy to forget that the first increase in the cash rate in this cycle was as recently as 4 May, yet already, mortgage repayments are up, retail activity is down and sentiment is in the toilet. But these changes will take months or years to show up in the CPI. Inflation data is like an old photo: a nice memory but you're different now.

What it all means is the Reserve Bank can afford to be patient. Big chunks of today’s inflation should fade and there’s little sign of the kind of wage-price spiral that could entrench it. Higher rates in Australia will not drain soggy lettuce fields or lower container freight costs.

Robust economic growth and the lowest unemployment rate since Whitlam clearly demand interest rates well above zero, but let’s avoid a rush job that breaks the economy.

No doubt Governor Philip Lowe and the Reserve Bank board feel silly for having left rates on hold for too long. Lowe has admitted his rate guidance was “embarrassing”. Fair enough. But there’s little sense in looking silly again for hiking them too fast.

More from Morningstar

Catch up on what happened this week in the usual place.

Consumer stocks dipped this week after Walmart dropped its second profit warning this year. Investors have good reason to fear the same could happen here. The mining sector is also in for a tougher time, with Morningstar cutting fair values across the board as commodity prices sag.

The collapse at US technology giants like Meta Platforms and Netflix set the stage for this year’s bear market. But there are signs a turnaround could be on the cards. On the theme of investments, Graham Hand explores ways to adjusted and protect investment returns for inflation.

Finally, as money managers everywhere scour the data for signs of capitulation, Morningstar’s Ruth Saldanha explains what this all-important concept means.

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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