Introduction

Early signals that of a peak in inflation led to an initial rebound in sharemarkets from their June lows as markets got excited that central banks would start to ease up on aggressive rate hikes. However, central banks have been cautious to confirm a “pivot” from an aggressive rate hiking cycle (as we saw with Fed Chair Powell’s speech at the Jackson Hole central bank symposium) as it is unclear when inflaton will slow and by how much. We look at whether peak inflation has been reached in Australia and globally in this Econosights.

Recent inflation trends

Recent leading indicators of inflation have shown some signs that global inflation will slow from here, including:

• A fall in goods spending after the Covid-related surge in 2020/21 which is helping to ease supply chains. US retail sales volumes are down by 3% over the year to July (on a quarterly basis). Australian retail spending was weak in June but rebounded in July, so is yet to show signs of significant slowing.
  

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• An improvement in supply chain issues caused by COVID-19, with delivery times, shipping rates and semiconductor prices all improving and well down from early 2022 highs (although still not back to its pre-2020 levels) as consumer goods demand has slowed, global travel has rebounded and employee absenteesim related to COVID illness has improved.
  

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• A decline in commodities prices from their highs, with declines in agricultural prices (like wheat, grain, cotton and soybeans), oil and metals (like aluminium, copper and silver). However, non-oil energy prices continue to rise, especially in Europe.
  

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However on the other hand, there are also opposing forces that could keep inflation higher for longer:

• Rental inflation will rise further. Australian rents in the consumer price data are up by 1.6% over the year while asking rents (which represent newly negotiated agreements) are up around 13% year on year for units and 12% for houses (see the chart below) with the big difference between the two reflecting historical rental lease agreements which still need to be renegotiated.
  

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• Wages growth will rise further in Australia which could drive inflation higher as staff costs tend to be around 70% of business costs. US average hourly earnings are running at between 5-7% year on year on various wage trackers while Australian wages growth was at 2.6% over the year to June and we expect a peak at 3¾% in 2023.
  

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• The breadth of large increases in prices is high, with 89% of components in the US CPI basket seeing a 3% increase in prices over the year to July and 65% of Australian components having a 3% year on year increase as at June (see the chart below).
  

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• European energy prices remain stubbornly high and continue to increase (European gas prices are up by 160% since June while US gas prices are just slightly up on their June highs) which will cause a higher and later peak in European inflation.

The outlook for inflation

In the short-term, inflation is expected to decline relatively easily in the US as the contribution from falling commodity prices will more than offset some of the broader high inflation pressure (like wages and rents). However, the risk is that some of those longer-run inflation drivers end up lifting inflation later on (which already looks to have started). So, the US consumer price index is likely to end the year around 6-7% per annum (well down from a peak of 9.1% in June). But, consumer price inflation is very unlikely to get back to 2-3% quickly in 2023 and is likely to remain sticky around 3-4% in 2023 as some of the longer-run inflation pressures keep price growth elevated. This means that futher rate hikes should be expected.

A pick up in domestic inflation has lagged the rest of the developed world, so the peak in inflation will also come later. We expect headline consumer price inflation to peak around 7.5% by December 2022, 5.5% by mid-23 and 3.5% by late 2023. Relatively lower wages growth in Australia compared to global counterparts means that there is less flow through from wages growth to inflation.

Inflation in Europe may not peak until early 2023, when energy prices start to decline which will result in a challenging economic environment for Europe over 2022/23.

Implications for central banks

While headline inflation may decline (in year on year terms) over coming months, price growth is likely to remain above inflation targets in 2023, so central banks will continue raising rates into next year (although probably not at the same pace as recently), keeping downward pressure on economic growth and corporate earnings. In the near-term this means more downside risk to shares, until it is clear that central banks will start to ease up on rate hikes.