Inflation hits 21-year high: are we headed for stagflation?

Australia’s headline annual Consumer Price Index (CPI) increased sharply during the second quarter of the year, sparking concerns we may see the return of an economic concept not experienced since the 1970s - stagflation.

The Australian Bureau of Statistics (ABS) reported that annual CPI rose to 6.1% year-on-year in June, spurred on by expensive new dwelling purchases, dizzying fuel prices and steep furniture costs.

Primary drivers of inflation

• New dwelling purchases by owner occupiers rose 5.6% quarter-on-quarter in June owing to a shortage of building supplies and labour, high freight costs and intense levels of construction activity. Fewer grant payments from the federal government's HomeBuilder program and similar state-based housing construction grants also contributed to the rise.
• Fuel costs continue to influence inflation, up 4.2% on the previous quarter as a result of global sanctions imposed on Russian oil and the easing of COVID-19 restrictions upping demand.
• Furniture prices rose 7.0% quarter-on-quarter due to increased transport and manufacturing costs.

Source: Australian Bureau of Statistics, Consumer Price Index, Q2 2022

Inflation rose 1.8% quarter-on-quarter in June, slightly lower than the 2.1% hike in the previous quarter when annual CPI reached 5.1%, the fastest pace of annual price growth in 21 years.

June’s release marks the highest annual CPI rate recorded since June 2001, when annual inflation also reached 6.1%. Higher levels of inflation had not been seen since a decade earlier in the December quarter of 1990, when the annual rate jumped to 6.9%.

The latest prediction from Reserve Bank of Australia (RBA) governor Philip Lowe is that inflation may climb to as high as 7% by the end of the year.

The national target inflation rate is 2-3%, on average, over time. Maintaining inflation at this level is intended to achieve price stability and promote steady economic growth. This approach to monetary policy in Australia was first referenced and proposed in the early 1990s.

Are stagflation risks mounting?

“After a 50-year absence, stagflation is fully back on the radar and we now need to be particularly disciplined,” Swiss Re Group chief economist Jerome Haegeli said in the insurer’s latest sigma report released in April.

The premise of stagflation is a shrinking economy that’s suffering high unemployment and soaring inflation. These circumstances last transpired globally in the 1970s.

What triggered stagflation then? In 1973, the Arab state members of the Organisation of the Petroleum Exporting Countries (OPEC) restricted the supply of oil to the global market causing a commodity price shock.

This was done in protest of the United States’ support for Israel in the Yom Kippur War, according to research from Yale University, Connecticut. The U.S. and other world economies, including Australia, suffered a lengthy period of stagnating recession and intense inflation - hence the term stagflation.

To combat these circumstances, Australian policymakers turned to a new fiscal plan in the 1980s which tolerated higher levels of unemployment. Between the mid-1940s and early 1970s unemployment in Australia averaged less than 2%. However, during stagflation unemployment rose and this helped to combat inflation. This economic model has been entrenched ever since.

Australia's unemployment rate sank to just 3.5% in June 2022, the lowest it's been in 48 years. If this figure were to rise it wouldn’t be as distressing as in previous decades and may be a necessary evil to help curb spiking inflation over the short term.

While it is a worrying prospect and we may see elements of this concept on the horizon, it’s unlikely that Australia will be subjected to outright stagflation. Our economic circumstances have changed dramatically since the 70s and 80s and we’re better informed to deal with disruptions to the global economy, such as Russia’s invasion of Ukraine and the COVID-19 pandemic.

“If people setting prices and wages were to believe that higher inflation will persist, they are more likely to push prices and wages up. This could result in a self-reinforcing cycle: one in which higher inflation leads to firms being more willing to put their prices up and agree to larger wage claims, which then perpetuates the higher rate of inflation, and the cycle repeats itself,” RBA governor Phillip Lowe said in a speech last week. 

“This is what happened in the 1970s and it ended badly. There is little evidence of such a cycle at present and it is important that this remains the case.

“The RBA is committed to ensuring that the current period of higher inflation is only temporary and it will do what is necessary to bring inflation back to target,” he said.

However, it’s plausible that we’re on the precipice of an economic crash. Market analysts suggest Australia may experience a mild recession by the end of 2023, so it’s worthwhile getting your finances under control ahead of any potential downturns.

With the latest cash rate hikes occurring as a result of inflation and unemployment at a 50-year low it seems likely that the RBA will raise interest rates again next week. How high will they go?

Inflation is affecting every aspect of Australian finances at the moment, from the cost of lettuce to home loan interest rates. When will it reach its peak?

If your home loan's interest rate is making your repayments unaffordable, consider comparing refinancing options.

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