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Australia reported its first inflation print for the year and it wasn’t what any stakeholder wanted to hear. In the three months to 31^st March 2024, inflation came in at 1% which was higher than expected. Moreover, the result puts policymakers in a tricky position as the RBA is scheduled to meet to discuss interest rates in May, while the Federal government is due to reveal its budget in the same month. This week ABSI looks at the implications of sticky inflation in the Australian economy.

The latest inflation figures from the ABS were not what anybody wanted to see. Over the past 12 months, headline inflation was recorded at 3.6%. The Q1 2024 print of 1% was above the consensus of 0.8% and a reacceleration of inflation from 0.6% in December last year. Trimmed mean inflation, the RBA’s preferred figure when setting monetary policy, also came in hot at 4%.

This data is bad news for mortgage holders who have been hoping for interest rate relief in 2024. Instead of cuts, some forecasters are calling for hikes from the RBA with the market pricing a 50% chance of a 25 bps increase this year. Top forecaster, Warren Hogan, from Judo Bank is expecting three more hikes to take the cash rate to 5.1% in order to get the job done.

Source:  AFR

One factor that will influence future rate decisions is the upcoming budget due for release on May 14. Despite small surpluses in the first two budgets of the Albanese government, these have come as a result of higher-than-expected revenues and not from cuts in spending. In fact, net discretionary spending has increased by a total of approx. A$36 billion.

Cost-of-living pressures are difficult for low-income earners and unpopular for sitting governments, which is why there has been a strong reliance on subsidies. However, these subsidies have only added fuel to the inflation fire. The money freed up from one expense is not being saved but is being spent elsewhere in the economy. Leaks about the upcoming budget hint at continued subsidies which won’t help the RBA’s cause. Couple increased government spending with the upcoming Stage 3 tax cuts, and we have a recipe for higher future interest rates.

Source:  AFR

Australia isn’t alone in its sticky inflation problem, many other developed economies are experiencing a similar issue, most notably the US. Investors in the US had been expecting rate cuts as early as March 2024, but these expectations continued to be pushed back as inflation remains elevated as a result of strong GDP and low unemployment, despite interest rates at 5.5%. The Fed’s failure in getting inflation under control isn’t its fault, it's fighting a battle with both hands tied behind its back thanks to federal budget deficits equating to 6% of GDP or over US$2 trillion dollars. If this state of play continues, it is likely that the Fed will have no choice but to raise rates further.

The US is a cautionary tale for Treasurer Chalmers as he hands down his third budget. The RBA has a job to bring inflation back into range, but it only has one tool at its disposal to achieve this goal. If the government doesn’t want to work with the RBA on achieving the goal together then it will be left with little choice but to enact more interest rate pain.

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