Australian inflation has jumped to the highest levels in 21 years, smashing expectations and adding to speculation the Reserve Bank of Australia will raise the cash rate in the weeks leading up to the Federal Election.

Australia’s Consumer Price Index (CPI), a measure of price changes for a basket of household items, rose 2.1% in the March 2022 quarter and 5.1% annually, the highest level since 2001.

The RBA’s preferred measure of inflation is trimmed mean – an indicator that reduces the impact of irregular or temporary price changes in the CPI. This similarly rose 1.4% over the quarter while the annual trimmed mean inflation increased to 3.7%, lifting above RBA’s target bank for the first time since 2010 and placing further pressure on the bank to lift the cash rate next week.

Australia's latest figures follow a surge in inflation around the world. US, UK and Canadian annual inflation all surged in March, adding 8.5%, 7% and 6.7% respectively.

New dwellings, automotive fuel, tertiary education biggest contributors to inflation

March data confirmed a lift in inflation across a wide range of consumer goods and services. In the March quarter, 56% of CPI categories had a price rise of more than 3% over the quarter, compared to just 35% last quarter, data from AMP Capital shows.

New dwellings and automotive fuel were the biggest contributors to headline annual inflation, up 13.7% and 35.1% respectively.

Head of prices statistics at the Australian Bureau of Statistics (ABS), Michelle Marquardt attributed the increase in prices for dwellings to “continued shortages of building supplies and labour, heightened freight costs and ongoing strong demand”.

Russia’s invasion of Ukraine, combined with easing Covid-19 restrictions, saw fuel prices spike around the world, Australia included.

Tertiary education rose 6.3% due to the introduction of a new band and fee schedule.

ABS reported that non-discretionary annual inflation, or the inflation that consumers can’t avoid, is more than twice the rate of discretionary inflation. The former includes goods like food and petrol and services such as housing and health costs.

Groceries also a big contributor in the March quarter

Other notable rises included the food group, up 2.8%, reflecting “high transport, fertiliser, packaging and ingredient costs, as well as COVID-related disruptions and herd restocking due to favourable weather,” according to the ABS.

Vegetable prices rose 6.6%, waters, soft drinks and juices up 5.6%. Fruit and beef added 4.9% and 7.6% respectively.

The only major large price fall was in international holiday travel and accommodation (-23.1%) thanks to a fall in airline prices.

All eyes on RBA May meeting

While many were predicting the Reserve Bank of Australia Board would wait until after the May Federal Election, economists now have their sights set on next week’s meeting. AMP Capital head of investment strategy and economics and chief economist Shane Oliver is expecting a 0.4% hike in May, taking the cash rate from its emergency covid-levels to 0.5%.

“The latest inflation blowout adds significant pressure on the RBA to immediately start raising rates and to do so more aggressively than initially thought likely,” he says.

Russel Chesler, head of investments and capital markets at VanEck, agrees, saying the quick pick up in inflation well above market expectations means there’s a “greater chance that the RBA will increase official interest rates in May.”

The ASX 30 Day Interbank Cash Rate Futures May 2022 contract shows markets are now betting there's a 42% chance of the RBA lifting the cash rate to 0.5% next week.

If the RBA does raise next month, this is before the Board gets to see March quarter wages data due on 18 May. The RBA previously indicated that it was inclined to wait for the figures, which Oliver says may annoy the Government amid an election campaign. But he believes delaying will only “risk an escalation in inflation expectations”.

“With the jobs market so tight it’s only a matter of time before wages growth picks up and various surveys suggest that it’s already doing so anyway and waiting till June to raise rates will probably have little impact on the election outcome as everyone knows rate hikes are coming anyway,” he says.

“We expect the first hike to be 0.4% taking the cash rate to 0.5%. We expect another 0.25% hike in June and now see the cash rate rising to 1.5% by year end.”

Chesler expects monthly increases bringing the RBA rate to 1.75% to 2.25% by year end. He says this will place significant upward pressure on mortgage lending rates, which the big banks have already increased.

Inflation is here, but how long will it stay?

Oliver expects the impact of supply-chain disruptions to wane towards the end of the year “as supply backlogs ease and consumer good demand declines”. He also blamed floods in NSW and QLD for the high price of fruit and vegetables, meat and seafood, which he similarly describes as temporary.

While Oliver says there are some temporary factors leading to the rise in inflation, he says impacts from higher commodity prices and supply chain issues could persist until the end of the year. “This means we haven’t reached the peak in annual inflation yet."

VanEck’s Chesler says global inflation is showing no signs of slowing down. He references China’s zero-Covid strategy and lockdowns saying Australia could see supply chain bottlenecks worsen.

In this environment, Chesler says the Australian sharemarket, dominated by miners and value shares like the big banks, is likely to outperform the US.

“[These areas] can benefit from wider margins as rates rise,” he says.

“In contrast, the technology-heavy US share market has dropped this year on higher bond yields. VanEck expects this trend to continue through 2022 given higher commodity prices are likely to persist and support the Australian share market even as bond yields and inflation rise.”