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Economist warns of ‘significant risks’ to inflation outlook

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Negative productivity growth, coupled with stronger wages, presents a “big problem” for Australia’s inflation story, according to Challenger’s chief economist.

Challenger chief economist Jonathan Kearns has warned that inflation may prove more persistent than the Reserve Bank of Australia (RBA) currently expects.

Dr Kearns, who previously spent 28 years at the RBA and most recently served as its head of domestic markets, noted that Australia’s central bank currently expects inflation to return to its 2 to 3 per cent range by the end of 2025.

“The risks are, at the moment, certainly to inflation being higher than that, just based on … we’re starting to get a bit more stronger wage growth. We even saw the government’s own wage agreement the other day was 11.8 per cent for three years,” he told InvestorDaily.

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“[Wages growth] is tapering down but you’re tapering down to 3.5 per cent, which I think is probably still a bit too high to get inflation back down to 2.5 per cent. So the risks are certainly a little bit higher.”

According to Dr Kearns, bringing inflation down is a multistage process, the first stage of which he characterised as “relatively easy” given that much of it is linked to supply chain disruptions and related issues.

Australia is now in the second stage, Dr Kearns said, which means tackling inflation that has become “baked into the system”.

“Getting inflation back down to maybe 4 per cent, 3.5 per cent, that’s going to be simpler, but then getting it back down to the rest of the 2.5 per cent, that could be harder. So there’s a lot of uncertainty with regards to what happens with inflation,” he stated.

Dr Kearns also touched on Australia’s productivity problem, pointing out that productivity growth has been negative since before the pandemic.

“Workers in Australia, as measured by the best data we have, have become less productive, and that’s a big problem when it comes to how that fits in with our inflation story,” he said.

The RBA has indicated that wages growth of 3.5 per cent would be acceptable if productivity growth sat at 1 per cent. But given productivity’s historic movement, Mr Kearns is doubtful that a boost to 1 per cent is realistic.

“That’s a big risk because we’ve got to get productivity growth from being negative to being 1 per cent and if we look at the evidence from before the pandemic and internationally, I think it’s unlikely we’re going to get productivity growth of 1 per cent. I think getting back to half a per cent is probably more realistic,” Dr Kearns predicted.

“If we do have wages growth of 3.5 per cent, that means you’re not going to get inflation back down to 2.5 per cent, the middle of the RBA’s target range. So I think there are these significant risks around inflation looking forward.”

Dr Kearns, however, reiterated the significant uncertainty in Australia’s inflation outlook and acknowledged that his forecasts may not eventuate.

“I can be wrong, anyone else who is making predictions can be wrong. We don’t know whether inflation over the coming year will be 4 per cent or 4.5 per cent or maybe we’re all surprised and it’s 3 per cent,” he said

“There’s a lot of uncertainty and even if you look at the RBA’s own inflation forecasts, they produce error bands around those to say just how much uncertainty there is, so that’s worth taking into account.”

While many economists at the start of 2023 expected a spike in inflation and interest rates to trigger a recession, Dr Kearns noted that the chances of a soft landing have progressively lifted as the year has progressed.

However, he pointed out that Australia’s GDP per capita was in decline over the first two quarters of this year.

“If we think about what a recession is and why we care about a recession, it’s really about living standards. Individuals, people, their living standards, and so it actually makes more sense to think about a recession on the base of GDP per capita,” he explained.

“On that basis, Australia has been in a recession over the first half of the year because living standards – GDP per capita – were declining. But I think it’s also useful to destigmatise what a recession is.

“We have this story in Australia, where Australia didn’t experience a recession for 30 years. Well, in fact, if you measure GDP per capita as the basis, there were three recessions during that time period. So they happen. The important thing is to make sure that you don’t get a deep recession.”

In Dr Kearns’ view, Australia’s strong and stable financial system will help it to avoid recessions like those seen in the early 1980s and early 1990s.

“What we’re looking at is probably some low growth for another few quarters before you will eventually get some recovery,” he concluded.

Economist warns of ‘significant risks’ to inflation outlook

Negative productivity growth, coupled with stronger wages, presents a “big problem” for Australia’s inflation story, according to Challenger’s chief economist.

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Jon Bragg

Jon Bragg

Jon Bragg is a journalist for Momentum Media's Investor Daily, nestegg and ifa. He enjoys writing about a wide variety of financial topics and issues and exploring the many implications they have on all aspects of life.

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