‘Inflation inertia’ to impact 2023-24 financial year, warns Westpac
Strong labour markets, slow productivity growth and emerging risks means progress on inflation may be slower than anticipated, chief economist Bill Evans warns.
A range of factors is creating inertia for inflation which is expected to continue well into 2024, according to Westpac Group chief economist Bill Evans.
Mr Evans said that many of these factors have been overlooked by markets in a recent economics research article.
The continued strength of labour markets is one of the factors he believes is driving the inflation rate to stay higher for longer.
“We have recently upgraded our forecasts for employment growth and lowered our unemployment rate forecasts, to reflect the consistent upside surprises on jobs and the persistence of 50-year lows in the unemployment rate,” said Mr Evans.
“The strength reflects the extraordinary backlog of unfilled jobs with job vacancies remaining at extreme highs. This is another direct legacy from the pandemic – and an issue being faced by many developed economies coming out of COVID. This resilience in labour market outcomes boosts incomes and demand adding to pressure on wages growth.”
Slow productivity growth has been a consistent concern for the Reserve Bank of Australia and could also slow the downwards trends in inflation.
“This was most clearly identified in the minutes to the RBA meeting in May, which noted: ‘Members observed that the forecast for inflation to return to the top of the target band by mid-2025 was predicated on productivity growth returning to around the modest pace recorded prior to the pandemic. If this did not occur, growth in unit labour costs would be uncomfortably fast,” said Mr Evans.
“The latest update on unit labour costs – wages adjusted for productivity – saw annual growth lift of 7.0 per cent to a very strong 7.9 per cent in the March quarter.”
The resurgent housing market may also make it more difficult for the RBA to achieve its inflation target.
“Nationally house prices have lifted by around 5 per cent since February, and the Westpac-MI House Price Expectations Index shows consumers expect gains to continue over the next year, which will anchor and support current momentum,” said Mr Evans.
Oil prices and electricity costs also look like a persistent source of high inflation.
“Global food prices are being impacted by Russia’s blockade of Ukraine’s agricultural exports and are at risk of more weather-related impacts as an El Nino forms,” he said.
Mr Evans said that the RBA’s forecasts of reaching the top of the band by mid-2025 already envisage a very significant fall in inflation through the remainder of 2023.
“Underlying inflation is forecast to fall from 6 per cent in June to 4 per cent in December. That entails a slowdown in semi-annual inflation from 2.2 per cent in the first half of 2023 to 1.8 per cent in the second half of 2023.
“We think that is achievable but expect progress in 2024 to be much slower as goods disinflation runs its course, and the emphasis moves to more persistent services inflation.”
About the author
