Higher energy prices and rents adding to inflation and threat of rate rises

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Rising energy prices and rents will add substantially to cost-of-living pressures over the next year or so despite the Reserve Bank’s efforts to tackle inflation, with the bank warning more interest rate rises may be needed to bring the economy under control.

Inflation is falling slightly faster than the central bank expected, slowing economic growth this year. But it is also hastening the prospect of real increases in wages, which are now forecast to grow faster than inflation by the middle of next year.

Reserve Bank governor Philip Lowe. The bank says it will keep raising interest rates if data shows inflation is taking too long to fall.Credit: James Brickwood

But the RBA’s Statement on Monetary Policy, released on Friday, shows the bank remains concerned inflation could stay high for too long, despite the official cash rate being lifted from 0.1 per cent to 3.85 per cent over the past year in a bid to rein it in.

“Underlying inflation is expected to take a couple of years to return to the inflation target. However, it is possible that the easing in inflation takes longer than this,” the statement said.

If inflation remains too high, wages could start chasing higher prices, and then prices would chase wages. The RBA said that would lead to even higher interest rates and a big increase in unemployment as it worked to bring inflation back down.

“High inflation makes life difficult for people and damages the functioning of the economy. And if high inflation were to become entrenched in people’s expectations, it would be very costly to reduce later,” the report said.

In February, the bank forecast the economy to expand by 2.3 per cent this financial year before easing to 1.4 per cent in 2023-24.

But Friday’s forecasts show the bank’s tightening of monetary policy will slow the economy much faster. It is now expecting growth of 1.7 per cent this financial year and just 1.25 per cent for the calendar year.

Inflation data last month pointed to a slightly quicker slowdown in price pressures than the bank had been expecting.

It now expects inflation to fall to 6.3 per cent this financial year rather than 6.7 per cent. By the end of 2023, inflation is tipped to be 4.5 per cent, below its previous forecast of 4.8 per cent.

The RBA said energy costs were likely to increase this year and, despite government intervention expected in Tuesday’s federal budget, would add 0.25 percentage points to inflation in 2023-24.

“Energy prices are expected to add significantly to inflationary pressures over the coming year,” the report said.

Inflation is still expected to be at 3 per cent by the middle of 2025 – the top of the bank’s 2 to 3 per cent target range.

Rising rents are a key driver of inflation, and the RBA also warned rental inflation could remain higher for longer than forecast.

“Rent inflation is expected to continue to pick up over the next year or so, and to add materially to inflation over the forecast period,” the report said.

“Rental vacancy rates are low and stronger population growth will contribute to further tightness in the rental market in the period ahead.

“As a result, rental price inflation is expected to increase further over coming quarters as higher rents work their way through the stock of outstanding rental agreements.”

The slowdown in growth has forced the bank to marginally increase its forecasts for unemployment. It is now expected to reach 4 per cent by year’s end and gradually lift to 4.5 per cent by mid-2025.

The bank expects wages to grow faster than inflation by the middle of next year. That’s despite the RBA slightly downgrading its expectations for wages growth, which is now tipped to peak at 4 per cent by year’s end rather than 4.2 per cent.

The central bank acknowledged that rate rises were already squeezing many household budgets and said it was mindful of the benefits of keeping the unemployment rate as low as possible.

But it said it was vital for people to expect inflation to reduce to its target range in the medium term.

“Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will depend upon how the economy and inflation evolve,” the report said.

“The board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that.”

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