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Labour costs to drive inflation to 6% peak

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The RBA expects higher labour costs in response to a tight labour market to become the primary driver of inflation.

The Reserve Bank of Australia (RBA) has made significant updates to its CPI forecast after March quarter inflation climbed to levels not seen since the introduction of the GST in 2001.

The RBA now expects the consumer price index to peak at 6 per cent at the end of the year, compared to 3.25 per cent it projected in February, before beginning its descent into more comfortable territory.

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According to the central bank’s latest statement on monetary policy, CPI should subside to 4.25 per cent by June 2023, before reaching 3.25 per cent at the end of the year.

Underlying inflation – the bank’s preferred measure - is forecasted to increase to around 4.75 per cent in the second half of 2022 before easing back towards the top of the inflation.

Acknowledging the “substantial” revision of the forecast profile for underlying inflation, the RBA said that the impact of the war in Ukraine and renewed lockdowns in parts of China have played a major part.

“The effects of these cost increases on consumer prices have also broadened over recent months. A significant share of firms in the Bank's liaison program have increased prices or expect to increase their prices over coming months as a result of the sustained rise in input costs,” the RBA said.

The RBA has based its forecasts on some technical assumptions, including the expectation that the cash rate will reach 1.75 per cent in the December quarter of 2022 and 2.5 per cent at the end of next year.

Unemployment, it noted, is expected to contract to 3.75 per cent in December before tightening further to 3.5 per cent, where it is predicted to remain for the long term.

The RBA noted that while the impacts of Ukraine are expected to subside, later in the forecast period the main contributor to inflation is expected to be the increase in labour costs resulting from a tight labour market.

“Higher labour costs in response to a tight labour market are expected to become the primary driver of inflation outcomes later in the forecast period,” the bank said, outlining wages growth of 3.75 per cent by mid-2024.

Other key sources of uncertainty include the future evolution of COVID-19, changes in price and wage-setting behaviour at historically low levels of unemployment, and the response of households, firms and asset prices to higher inflation and interest rates.

Last week, the RBA chose to lift the cash rate from a record low 0.1 per cent to 0.35 per cent in its first rate hike in over a decade.

"The board judged that now was the right time to begin withdrawing some of the extraordinary monetary support that was put in place to help the Australian economy during the pandemic," governor Philip Lowe said in the bank's post-meeting statement. 

"The economy has proven to be resilient and inflation has picked up more quickly, and to a higher level, than [what] was expected. There is also evidence that wages growth is picking up. Given this, and the very low level of interest rates, it is appropriate to start the process of normalising monetary conditions," he added. 

Commenting on the RBA’s bold move, GSFM investment strategist Stephen Miller said the central bank has “has done a lot to consolidate its inflation credentials and preserve the appearance of independence”.

Currently financial markets are pricing a policy rate of close to 2.5 per cent by year-end.

And while Mr Miller acknowledged that these forecasts appear excessive, he noted they’re “within the realm of plausibility”.

Labour costs to drive inflation to 6% peak

The RBA expects higher labour costs in response to a tight labour market to become the primary driver of inflation.

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Maja Garaca Djurdjevic

Maja Garaca Djurdjevic

Maja's career in journalism spans well over a decade across finance, business and politics. Now an experienced editor and reporter across all elements of the financial services sector, prior to joining Momentum Media, Maja reported for several established news outlets in Southeast Europe, scrutinising key processes in post-conflict societies.

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