While an announcement from the RBA yesterday confirmed the cash rate would remain at the all-time low of 0.1 per cent, concerns are mounting over growing inflationary pressures.
Since its last meeting in November, the bank’s policy has remained unchanged and will almost certainly remain unchanged until its next meeting in February.
However, a weak Australian dollar has stoked fears of inflation.
Dollar falls
Since early November, the AUD has fallen from 75.5 US cents and is hovering around 71 US cents.
The local currency has slumped to its weakest level since July of 2020, dropping 7 per cent since the year began.
This is bad news for Australia’s economy, which is already facing mild supply-side inflationary pressure.
The lower the value of the dollar, the more of it we need to buy something made in another country. This extends to retailers and suppliers and directly to consumers passing the cost throughout the economy.
AMP Capital’s Shane Oliver said, “If it [AUD] falls 10 per cent, then all things being equal, imported prices rise 10 per cent, and they are about 20 per cent of the CPI, so spread over a year, it would add 2 per cent to prices.”
This means more money is needed to buy the same amount of goods. If the dollar keeps losing ground, it will add to existing inflationary pressure.
The higher the level of underlying inflation at the RBA’s next monetary policy meeting, the more likely it is that the first cash rate increase will be brought forward.
Why has the dollar fallen?
There are a few explanations as to why the dollar might have fallen; they include:
- Prices of Australia’s largest exports (iron ore, coal and gas)
- Australian interest rates compared to other countries’ rates
- The perceived health of the Australian economy
- Broad demand for other countries’ currencies
- The level of anxiety on global financial markets.
Currently, commodities prices are under pressure, offshore interest rates are rising, and the pandemic is continuing to fuel anxiety around the global financial markets.
The rebound of the dollar depends on the culprit, which is difficult to discern. There’s a realistic chance the dollar may continue to fall below 70 US cents, but it could just as easily stabilise where it is.
Concern about inflation
After years in which inflation has been low and stable, suddenly, there’s a lot of attention being paid to inflation.
In the US, inflation rocketed to 5.4 per cent in the year to June 2021.
While Australia’s has experienced inflation, it has been primarily driven by superficially high petrol and housing prices and global supply chain issues. In underlying terms, inflation is at a reasonably low 2.1 per cent.
Brendan Coates, economic Policy Program Director at Grattan Institute, writes that inflation only becomes a problem when we perceive it as a problem.
In November, he wrote, “Sustained inflation is really only a risk when rising prices get factored into firms’ and workers’ expectations, but inflation expectations remain subdued, so it’s hard to be worried.”
If firms and consumers are concerned prices will continue to rise, they will bring forward their spending plans to avoid paying more in the future, stoking demand, and driving prices higher.
Mr Coates continued: “Supply bottlenecks that emerged as the global economy opened up will ease in the coming months. In the depths of the pandemic panic last year, Australia’s Consumer Price Index actually fell by 1.9 per cent in the June quarter. A lot of inflation reported now simply reflects those past price falls.”
RBA is patient
As it stands, the RBA is patiently waiting for the labour market to tighten and wages to rise before taking any action.
The Board stressed yesterday that they would not consider increasing the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. This will require a tight labour market to generate sustained wages growth higher than current levels.
RBA Governor Philip Lowe said, “While inflation has picked up, it remains low in underlying terms. Inflation pressures are also less than they are in many other countries, not least because of the only modest wages growth in Australia.”
However, the price of the Australian dollar will no doubt factor into any decision to be made in February. Should the RBA be forced to increase the cash rate on account of a weak dollar before wages rise, Australia’s long term economic recovery may be jeopardised.
Governor Lowe concluded his statements in a bureaucratic fashion, saying, “The Board is prepared to be patient.”
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