While inflation is starting to turn a corner in other advanced economies, Australian consumers have ended 2022 with a bang with prices expanding at the fastest pace in 33 years, all but confirming another interest rate hike when the RBA meets in February. 

If inflation persists longer in Australia than the US, that could cap the performance of Australian equities and bonds, though energy and food companies are riding the wave of higher prices, according to experts.

What the data shows

The Consumer Price Index (CPI) rose 1.9% in the December quarter, driven by higher travel and electricity costs. It takes the annual rate to 7.8%, data from the Australian Bureau of Statistics (ABS) revealed on Wednesday.

The largest contributors over the year were new housing - up 17.8% due to higher construction costs - fuel, which soared 13.2%, and food, up 9.2% over the year.

Even after stripping out some of the more volatile price movements, underlying inflation rose to 6.9% annually, up from 6.1% in the September quarter. That is the highest level since the measurements began in 2003 and well above the RBA's 2% to 3% inflation target.

Interest rates have further to run

The Australian dollar surged on the back of the data, as market expectations for a February rate rise jumped from 52% to 92%. Economists also unanimous, with Judo Bank’s chief economic advisor Warren Hogan calling for a larger-than-usual 40 basis point increase. 

"They are behind the game and hoping the economy slows enough to bring inflation down," Mr Warren said in a Tweet, adding the pivot to smaller 25 basis point increases hasn't worked.


The RBA is expected to resume rate hikes when it meets in February. Picture: AP

BetaShares chief economist David Bassanese expects the RBA to raise rates by 25 basis points in February, with a follow-up and final rate rise of the same amount in March.

“While the inflationary pressures evident in Australia are partly supply related, such as higher food prices, strong demand is also playing a role – especially in allowing businesses to pass on costs so easily into final consumer prices,” says Bassanese.

GSFM investment strategist Stephen Miller says while inflation is moderating in the US, local inflation could remain entrenched.

“Data continues to indicate significant domestic inflation momentum as we go into 2023. The unemployment rate remains close to a 50-year low," says Miller.

"Well-intentioned but potentially flawed changes to the regulatory environment, particularly in relation to the wage-setting framework, run the risk of entrenching higher inflation in Australia compared to elsewhere."

Where to invest in times of high inflation

Scott Keeley, a senior financial adviser with Wakefield Partners, says inflation typically creates downward pressure on share prices, especially growth companies. However, providers of essential goods, such as supermarkets and energy companies could remain insulated.

“The ongoing need for food and energy make shares in companies in these sectors more likely to outperform in periods of high inflation. Commodity prices too typically rise with inflation, making mining and agriculture stocks potential safe havens,” says Keeley.

“Overall, though, a high-quality diversified portfolio containing exposure to the major asset classes should provide robust performance and peace of mind in all stages of the inflation cycle.”

Are supermarkets passing on the higher costs in full?

The CPI data shows grocery prices have soared over the past year, driven by dairy, bread and cereal, as producers pass on the higher costs to consumers, albeit not in their entirety.

UBS names Bega (BGA) as one company that stands to profit from rising dairy prices. In a research note, UBS says Bega is "successfully passing through the substantial increase in 2022-23 farmgate milk prices."

Bega is trading at a 25% discount to where Morningstar analysts see fair value. 

But is the market overestimating the positive impact of food price inflation on supermarket earnings? Morningstar's Johannes Faul suspects so, particularly for Coles (COL) and Woolworths (WOW) which are trading at a premium.

"We forecast Coles’ and Woolworths’ cost of doing business to increase by more than sales—mostly due to higher wages—and constrain EBIT margins," Faul says. 

Energy boost as investors seek defence

Shane Langham, a senior private wealth adviser with Sequoia Wealth, says hard assets are the best place to be in a high inflation environment - and in particular energy.

“The energy sector has been the best performing sector globally," Langham says.

"The Aussie energy sector is up about 48% since inflation started to rise locally in July 2021 to 24 January 2023, showing that energy stocks have been out doing oil. The one thing that we will need more of tomorrow then today will always be energy," he says. 

For investors unsure about which companies to buy, Langham says an energy sector ETF could be an option. 

“This way you don’t have to pick which energy stocks to include and which ones you have to leave out, unless you can buy them all and have the time to manage them, as you can just buy the ETF which closely matches the energy sector in one purchase,” says Langham.

Morningstar senior equity analyst Mark Taylor has placed 5-star rated Santos (STO) on the global equities best ideas list, saying it's not being sufficiently credited for new oil and gas developments underway.

Santos is currently trading at a near-40% discount to its fair value estimate.