Why a 2022 interest rate hike just became more likely

The Reserve Bank of Australia’s inflation forecasts have been blown out of the water as supply chain disruptions and petrol prices push up the cost of living. 

Economists say key data released Tuesday may force the RBA’s hand to raise interest rates this year, despite governor Philip Lowe repeatedly dismissing speculation of a 2022 hike.

^{Underlying inflation is now firmly within the RBA’s 2-3% target range. Picture: Getty}

The Consumer Price Index (CPI) rose a stronger-than-expected 1.3% in the December quarter, according to the Australian Bureau of Statistics, pushing the annual rate up to 3.5%.

Michelle Marquardt, head of prices statistics at the ABS said global supply chain disruptions and material shortages, combined with rising freight and fuel costs had driven up prices.

“Shortages of building supplies and labour, combined with continued strong demand for new dwellings, contributed to price increases for newly built houses, townhouses and apartments.” Ms Marquardt said.

“Fuel prices rose again in the December quarter, resulting in a record level for the CPI’s automotive fuel series for the second consecutive quarter.”

^{Source: Australian Bureau of Statistics}

The key measure of inflation that the RBA will be focused on is the trimmed mean, also known as underlying inflation, which reduces the effects of volatile or temporary price changes.

In the December quarter, annual underlying inflation rose to 2.6%, up from 2.1% in the September quarter, and within the RBA’s 2-3% target range for a second straight quarter.

“Annual trimmed mean inflation is the highest since 2014, reflecting the broad-based nature of price increases, particularly for goods,” Ms Marquardt said.

Growing anticipation for 2022 hike

So strong was the result, that it prompted economists to either bring forward their rate hike forecasts, or to concede the possibility.

Economists at CBA now expect the cash rate to begin rising in August 2022, three months earlier than in their previous forecast of November.

“We have made the case over the past year that the extraordinary fiscal expansion indirectly financed by money printing (i.e. quantitative easing) would generate a material lift in inflation. Today’s inflation data vindicates our view,” CBA head of Australian economics Gareth Aird said in a research note.

Inflation is well ahead of RBA forecasts. Picture: Getty

Mr Aird also opened the door to an even earlier move, which he said could be as soon as June.

“Our expectation for the labour market to continue to tighten, for wages growth to accelerate and for underlying inflation to push towards the top of the RBA’s target band from here means the risk lies with an earlier hike than August 2022,” he said.

It brings the forecast in line with Westpac, who last week tipped an interest rate lift off in August 2022.

EY chief economist, Jo Masters said underlying inflation can no longer be characterised as “low”.

“This will be an uncomfortable number for the Reserve Bank,” Ms Masters said.

However, she noted the economic impact of Omicron has since grown, with the inflation data only capturing the three months to December.

“While progress towards the inflation and full employment objectives has clearly been faster than expected, there continues to be considerable uncertainty for the economic outlook. Omicron has pushed Australia into a shadow lockdown, and confidence has taken a hit.”

HSBC chief economist, Paul Bloxham, who expects interest rates to rise in 2023, said the figures increased the chance of an earlier rate hike.

“On the RBA’s own November 2021 figuring today’s numbers would imply hikes are likely in 2023,”

“However, if the inflationary pressures maintain the currently quarterly momentum, and this was to get through to wages growth more quickly, then there is a risk of rate hikes earlier than this.”

What it means for interest rates

The RBA has remained steadfast that interest rates won’t rise until inflation is sustainably within its 2-3% target range.

The question is around what the RBA considers to be ‘sustainable’ inflation.

^{RBA governor Philip Lowe has repeatedly said a 2022 hike is unlikely. Picture: Getty}

In a speech last year, Mr Lowe said it wouldn’t be enough for inflation to “just sneak across the 2% line for a quarter or two,” and that the RBA wants to “see inflation around the middle of the target range and have reasonable confidence that inflation will not fall below the 2–3% band again.”

At 2.6%, underlying inflation is firmly within that target range, and well ahead of where the RBA had projected in their latest statement on monetary policy. Those forecasts had underlying inflation at 2.25% by the December quarter.

However, PropTrack economist Paul Ryan said temporary factors would still be captured in the underlying inflation figure, which would subside over the coming quarters.

“I still think the majority of the data is still comprised of temporary supply disruptions that are increasing inflation, and they’re just large enough to push around that underlying measure,” he said.

“I think the RBA is expecting that these disruptions we’ve had will fade away and, in turn, that will mean that the inflationary pressures on those specific components will fade.”

Mr Ryan said while the data had made it “more likely” that the RBA will lift rates in 2022, he said next year was still the most likely option.

“A speech by Philip Lowe next week will probably outline the board’s thinking on the future as well as reveal some of their updated economic forecasts,” he said.

“Given where market expectations are, a lightening of those expectations might be flagged.”

Wages growth ‘key’ to early rate hike

With many price pressures still considered temporary – such as material shortages caused by supply chain disruptions – Mr Ryan said wages growth will be important.

“The RBA is not going to act on rates until they see wages growth,” Mr Ryan said.

“If we see wages growth start to accelerate faster than the RBA expects, that’s something that would change my mind on whether interest rates will rise this year,” he added.

^{Wages growth data will be released in February. Picture: realestate.com.au}

According to Mr Lowe, wages growth of at least 3% annually is needed to have a meaningful impact on inflation. In the September quarter, the Wage Price Index showed an annual growth rate of 2.2%.

Wages growth data for the December quarter won’t be released until 23 February, after the RBA’s first board meeting of 2022 and after it releases the next round of economic forecasts.

Ms Masters said while an interest rate hike now looks increasingly likely to be “late this year”, she said the RBA’s actions will be data dependant.

“They will want to be assured of inflation remaining within their target band of 2-3% and an acceleration in wages growth to be underway,” she said.

“Now, they have the complex job of communicating this change to the market and households.”

She noted risks to consumer spending with households now facing higher prices for essential goods and services, as well as the prospect of higher mortgage rates.