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9 Jun 2023 - Hedge Clippings | 09 June 2023



Hedge Clippings | 09 June 2023

As previously suggested, it looks like inflation, and thus higher rates, are going to be more persistent, even if RBA Governor Philip Lowe suggested this week that it has "passed its peak". Having made that statement, he then went on to say that: ''Recent data indicate that upside risks to the inflation outlook have increased," which made it sound like he is having two-bob-each-way on the outcome.  And who can blame him (apart from the Treasurer) as he increased rates by 0.25% yet again, given the issues he outlined in the statement released following the RBA's meeting on Tuesday?

Against the background of a tight labour market, wages growth - not helped by an increase in award wages - is expected to pick up. Meanwhile, while there's been no improvement in labour productivity, resulting in a worrying increase in unit labour costs. Lowe's path to a soft landing - or in other words slowing the economy whilst avoiding a recession, is looking increasingly difficult to achieve with the latest GDP for Q1 just 0.2%, down from 0.6% in Q's 3 and 4, 2022.

In the US a recession followed the last five instances when inflation peaked above 5%, in 1970, 1974, 1980, 1990, and 2008. Indeed, the US economy recorded two consecutive quarters of negative GDP growth in Q1 and Q2 of 2022, technically qualifying as a recession, before recording a growth of 3.2% in Q3, 2.4% in Q4, and 1.3% in Q1, 2023.

Covid aside, the last recession in Australia was in 1990/91. With the median age in Australia currently just over 38, a large proportion of the population has never experienced a recession, which is maybe why the threat of an impending one is not yet biting into consumer spending. While the media is currently full of anecdotal evidence of economic hardship and mortgage/rental stress, this is unevenly spread across the population. A report from PEXA released this week shows that over 25% of all property purchases in Australia's eastern states were funded without a mortgage in 2022. Inflation is real, but the RBA's efforts to curb it are only changing the spending habits of a minority, and generally those with less or limited discretionary spending capacity.

Mortgage rates are only high by historical standards, magnified by the size of loans taken out to afford sharply higher property prices. In 2021, 35% of households had a mortgage, while 32% did not, and 28.4% were renters from private or other landlords. All the focus is on mortgage repayments and mortgage stress, and only more recently rental stress, resulting in interest rates (and to a degree inflation) not impacting a significant portion of the population. For the RBA this creates an issue, as the "enemy" - inflation - comes from all and many quarters, only some of which are homegrown or under domestic control.  

If Philip Lowe's rate increases to date have had limited effect on consumer spending and demand, then there's no doubt that "some further tightening of monetary policy may be required" along with an increased risk of recession. However with multiple inputs, and only interest rates as a tool, the RBA's "narrow path" is looking narrower - and decidedly slippery.

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