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A battle of two inflations

3 May 2022 1 month(s) ago

Asset inflation has been soaring; now it is the turn of CPI inflation.

The Australian economy is essentially a battle between two types of inflation: consumer price inflation (CPI) and asset (house price mainly) inflation. For over a decade the latter has vastly outpaced the former, but the balance looks like it is shifting, with CPI going above the Reserve Bank’s target range, presaging higher interest rates.

The impact of high CPI inflation and higher interest rates will probably be felt in lower consumer demand, which according to Morgan Stanley was already looking weak. Consumption is about 80% of the economy, so when it weakens it points to lower economic growth:

“Consumer sentiment fell 0.9% in April and marked the 5th consecutive monthly decline in sentiment. Inflation and interest rate concerns, geopolitical events and weather conditions likely all impacted sentiment negatively. The Federal Budget provided some offset, likely influencing an improvement in surveyed expected conditions.

“Cost of living impacts registered further with current conditions (-5.0%) being much weaker in the month and the lowest since August 2020, while in contrast, expected conditions rose (+2%) and remains above its long-run average - likely linked to Budget signals.

“Looking into the detail, consumers were more worried about their own finances with both current (-0.7s.d.) and expected (-0.3s.d.) family finances falling in the month weighed by the increased cost of living. In gauging the impact of inflation on confidence, we note the 5.3% fall in the ‘time to buy a major household item’ sub-index. This index has fallen by 10.7% in the past six months and is now 22% below its long-term average.”

Morgan Stanley says housing sentiment was weak in April, with price expectations falling 3.5%. But higher CPI inflation may not mean sharply lower house prices. SQM Research managing director, Louis Christopher, is arguing that the high inflationary period Australia is entering could actually prevent a house price crash even if mortgage rates rise sharply. Higher inflation tended to lift dwelling values.

“There is a chance here with accelerating inflation that investors and home buyers will flock to property to get a hedge against inflation,” he said.

“If we were to see a pick-up in real wage growth commensurate with inflation, similar to what we had in the 1970s, that will likely stop a hard landing in the housing market.”

Of course, that could be just optimism with many owners of houses having very large mortgages and Australia’s household debt extremely high.


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