Wayne Cole

SYDNEY, (Reuters) – A sudden spike in Australia’s energy prices threatens to keep inflation higher longer. This is why policymakers felt compelled this week to raise interest rates the most in 20 years and to warn that there are many more.

This surprising half-point rate hike to 0.85% was achieved at a time when consumer sentiment reached depths not seen since the worst pandemic. Also, house prices in Sydney & Melbourne were suffering a third month’s losses.

The Reserve Bank of Australia (RBA), among other reasons, stated that inflation had risen faster than anticipated a month prior.

Justin Smirk (Westpac Senior Economist) says, “The energy markets have been struck by a perfect storm”: rising demand, decreased output from coal-fired base load generation and record high coal prices.

The RBA is unlikely to experience this shock, given that it long believed inflation was less of an issue in resource-rich Australia simply because energy costs have not increased.

Australia was behind its industrialised counterparts, the United States of America and New Zealand when it came to reversing from the pandemic-mode monetary setting. It had previously urged caution on the effects of supply bottlenecks and price pressures. In May it delivered the first rate rise in more than 10 years.

In its third week of power, the Labor government has pledged to reduce the cost-of-living crisis through an October budget. However, it has not yet found a solution for the energy spiral.

Australia’s energy market operator capitulated wholesale gas prices in the southern US and enabled a first-ever guarantee mechanism for gas supply. The move was necessary because of a spike in heating demand during cold snaps.

Westpac’s Smirk sees inflation in consumer prices rising to 5.8% annually this quarter due to higher petrol and food costs. This is up from 5.1%, the 20-year high.

Smirk also warned that the prolonged nature of this problem could cause inflation to accelerate even further, reaching 6.6% by the fourth quarter. This is well beyond the RBA forecast of 5.9%, and it’s the highest rate since 1990.

Many signs are already present that firms have begun to pass on increasing costs to their customers. This is a significant change from years ago when tighter control was the main concern.

This week, the Melbourne Institute published a monthly survey showing that core inflation increased by 0.7%. It is the largest rise since 2009.

This was an increase of 4.0% in annual mean, which is the highest level since 2008, and well beyond the RBA’s goal range of 2-3%.

Taylor Nugent from NAB, an economist said “It indicates upstream cost pressures. We expect price pass through continued to accelerated into Q2’s beginning. And we expect another strong and trimmed mean result for July.”

On July 27, the official CPI report is due. The RBA could increase its preferred trimmed inflation measure to 4.5%. Last year, it was at 1.6%.

The RBA is clearly in an hurry and has more to do with rates.

Gareth Aird of the CBA’s Australian Economics Department stated that “The RBA Board had radically changed gear.” We expect another 50 basis-point rate increase in July because of the clear intent to bring inflation back on target.

Also, he sees quarter point moves in August and September as well as November taking rates up to 2.1%

However, the contractionary environment will cause economic momentum to slow. We therefore have planned rate cuts in late 2023.