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Do inflation and interest rates have to go sky high?

Peter Switzer
5 May 2022

Anyone who’s not worried about the threat of inflation probably hasn’t got a home loan, but let me assure you there are two opposing views on what happens to the prices that determine our purchasing power and wealth.

One says inflation will persist and force the Reserve Bank to raise interest rates five more times, probably by 0.25% before December to take the cash rate of interest to 1.5%. And this will take home loan interest rates up by a similar amount.

That could be a shocker for those overborrowed with a 0.25% rate rise adding $65 a month to a $500,000 home loan taking $780 a year. But if that happens five more times this year, it will be a $3,900 slug per year for borrowers.

It's why I can’t see that happening. I’m betting, say, three more at the most this year and then the RBA would be hoping to see inflation come off the boil, and I’m not the only one seeing this as a possibility.

Writing in The Australian, Ticky Fullerton looked at the predictions of Macquarie economist Viktor Shvets, who thinks runaway global inflation will swing back to disinflation very quickly, and that “the US Federal Reserve will back off from its aggressive rate-rising strategy in as little as 12 months”.

This would be great news for those likely to be mugged by too many interest rate rises and it should be good for stocks, that have been sold off on the basis that US rate rises could be so excessive that they could cause a recession. Incidentally, I’ve always argued that I didn’t think the Fed and our RBA are that stupid that they would create a recession on purpose.

Viktor told Ticky said that over the next 6 - 12 months, where he expects a more disinflationary trend (which means inflation persists but gets smaller with each reading) would be great for hosing down those fired up predictions of many interest rate rises. “People could be surprised how quickly some of those prices could retreat rather than be inflationary. But if you go further down the track to late 2023 and 2024, you could have another significant inflationary spike,” he says.

That is a bridge we will have to cross then and it’s why I like stocks in 2022 and 2023. But I was expecting to go more defensive later next year for reasons Viktor has been alluding to.

So what could hurt the ‘inflation will fall’ prediction? I suspect it could come from big wage demands, which will be an issue our next federal government will have to deal with.

Employers are already warning unions that excessive wage demands will mean higher interest rates but the union boss, ACTU secretary, Sally McManus, won’t have a bar of it.

The Australian says McManus points to the RBA, which says if real wage increases are less than productivity, then the pay hikes are not inflationary.

Wage rises increase costs, while productivity lowers costs, so you can see what McManus and the RBA are saying, but employers might question whether their workers are delivering productivity.

But the question of being able to afford a pay increase might differ from business to business and sector to sector.

The Australian Chamber of Commerce and Industry chief executive Andrew McKellar has a fair call on the subject, with The Australian’s Ewin Hannan telling us that “according to ABS data, three in five businesses had their costs increase more than usual in the past three months”.

This is because of supply chain problems, which include a lack of staff because foreign workers have gone missing since the pandemic. “Having survived the pandemic, small business owners are now confronted with rising input and labour costs,” Mr McKellar said. “Businesses with already thin margins have no choice but to pass on increased labour costs through higher prices, further spurring inflation. Unions’ calls for an aggressive increase in wages is irresponsible in an environment where ­inflation and supply-side constraints are expected to worsen.”

Clearly, retailers, miners, many builders and other boom sectors could handle pay rises but CBD businesses, tech companies, flood-hit operations, travel agencies and those crushed by closed borders need a period of grace before they’re expected to pay more for workers.

Interestingly, our federal and state governments, which now have big budget deficits in rescuing our economy might also find it hard to pay public servants wage rises but saying no to pay rises for the likes of teachers, nurses and the police, I reckon, will be a hard argument to win for many of our political leaders.

The bottom line is if wage rises do get out of hand, it will lead to price rises from businesses and it will power up inflation and more interest rate rises than many of us will be able to endure.

The only plus that could bring down inflation and offset excessive pay demands from unions is Viktor Shvets’ expectations that supply chain problems will dissipate over 2022.

For a win over inflation I hope Viktor is as smart as Macquarie thinks he is and so I say V, not for victory, but V for Viktor!

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