House prices are up, the share market is up, so why isn’t inflation?
In the post-COVID economy, the number one question is around what interest rates are going to do. More importantly, when will they increase?
As we know, the Reserve Bank is in charge of setting the official cash interest rate. The RBA met yesterday and unsurprisingly, has kept rates on hold. But they’ve gone further, stating:
“The Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range.”
As a reference point, inflation in December was 0.9%, so we can expect interest rates to stay at 0.1% for a while yet, probably until 2024 at the earliest.
The interesting thing though is that the economy looks to be booming, and you’d be forgiven for thinking that everything is on the ups in a big way.
Housing prices have gone mad, petrol is through the roof, and iron ore is booming. So if none of those are driving inflation, what is?
I’ve been hosting Money News on Nine’s radio stations across the country this week, filling in for Brooke Corte. Last night I chatted with Brendan Coates from the Grattan Institute on the topic of inflation. You can listen to the chat here.
Ultimately inflation is a reflection of demand versus supply, and we’ll only see inflation increase when there’s too much money in the economy, chasing too few goods. In other words, when demand outstrips supply.
We’re seeing something like that happening in the housing market at the moment, but the housing market isn’t what the RBA is watching – they’re watching demand for everyday consumer products, items that Australians buy routinely.
The real handbrake on inflation is wages growth. So while interest rates remain low, Aussies will feel like they have a bit more spending power and will likely put at least some of that into the economy, but it’s actually a reflection of savings growth due to low interest rates, rather than wages growth.
It won’t be until we see significant and sustained wages growth, that the economy will properly start to boom, inflation will start to creep up, and the RBA will start to consider bumping up interest rates.
The unknown in all of this though, is what the banks choose to do. The only answer we have to that at this stage, is to watch and wait.