Our latest quarterly economic update covers our domestic economy, including inflationary fears, rising cost of living prices, the recent basic wage increase, and the slowing of the property market. Cryptocurrency is also discussed.

The inflation story

The price of a lowly head of lettuce has never been a recognised barometer of the strength of the Australian economy, that is until the media started reporting iceberg lettuces were selling for $10 a head.

Suddenly, this has become a touchstone for everything that is wrong with the domestic economy. Prices are on the rise, spurred by higher transport costs and climate-based disruptions to the food chain, and the cost of living is surging.

While some relief came with an unexpected 5.2 per cent increase in the basic wage, a move endorsed by the newly elected Federal Government, the prospect of similar inflation linked wage increases were dismissed as a ‘baby boomer fantasy’ by the trade union movement.

Nonetheless, fears of further wage increases remain. So, all eyes are now focused on price rises with the most recent figures from the Australian Bureau of Statistics, pegging Australia’s rate of inflation at 5.1 per cent per annum.

As bad as this might seem, it is still one of the lowest inflation rates among OECD nations, beaten only by Japan and Switzerland, at the bottom of the inflation table with 2.5 per cent, followed by Israel on 4.0 per cent, and Korea and France with 4.8 per cent.

However, with inflation in the United States at 8.3 per cent and 7.8 per cent in the United Kingdom and both countries expecting this rate to go higher, the fear is Australia’s rate will start moving towards 7 per cent – a rate not seen in Australia for more than 20 years.

Inflation fears driving interest rates

Inflationary fears were made worse by the Governor of the Reserve Bank, Phil Lowe, calling for “front-loaded” interest rate hikes to avoid stagflation and warning against any super-sized wage claims.

Just the mere mention of stagflation, something not seen since the seventies, has sent a shiver through the economy.

This drove fears that home loan interest rates will also be pushed higher, causing more financial stress for those who have borrowed heavily and bought property at the recent record-high prices.

While all four of the big banks are reporting current home loan arrears at record low levels and the majority of customers are tracking well ahead on their home loan repayments, fears still remain about the impact of higher interest rates.

Property prices have already started to slide with industry analysts expecting the average prices in Melbourne and Sydney to fall by 10 per cent this calendar year and by potentially as much again next financial year.

Meanwhile, the value of cryptocurrencies, which seems to magnify prevailing market sentiments, has collapsed across the board with values falling by as much as 70 per cent.

The largest single cryptocurrency, Bitcoin, which was trading at just $US67.81 in July, 2013, soared as high as $US68,000 last November and is currently trading at $US20,200, with little market enthusiasm.

While cryptocurrency was once touted as being something of a safe haven and a means of diversifying investment portfolios, it is fast becoming a magnifier of market excess and pessimistic economic sentiment.

Not all bad news

The Australian unemployment rate dropped to a 48-year low of 3.5% in June, indicating we’re in relatively good shape. Likewise, business conditions have improved since 2020 and with no lock downs the economy is growing considerably, with our exports also surging.

There are signs that the recent aggressive interest rate rises are having an impact on consumer confidence and household spending, which may lead to lower inflation (and reduced pressure for further rate rises) in the coming months. Any indication of inflation slowing will lead to an expectation of lower interest rates in the future, and this would support the financial markets.

A slowdown in the US is highly likely for cyclical reasons, as the US economy is already extremely overstretched, inflation is probably close to peaking and whilst a slowdown/recession may be coming, it is more than likely to be a mild recession due to the strength of corporate balance sheets and the resilience of consumers.
For China, a recovery is highly likely as China is reopening following covid-related lockdowns and government policy is supportive.

The outlook and implications for investors

The factors driving economies and financial markets are as mixed as ever. While we still have significant negatives in the form of rising interest rates, inflation, war and COVID, there is still strength in global economies and a sharp awareness from central banks on the sensitivity of economies to interest rate changes (ie they don’t want to overdo it).
It is quite possible that we see the recent rate rises take their effect on inflation, and together with the temporary nature of some of the inflationary factors (war, weather, supply chain interruptions) we may see these negatives dissipate.
In many historical cases, financial markets overshoot on both the way up and the way down, and hindsight may prove this to be a good period for accumulating cheap investments. Time will tell.

Economic indicators – 1 July 2022	1 year % excluding dividends
Australia: ASX 200	-10.0
Japan: Nikkei 225	-9.7
China: CSI 300	-14.6
UK: FTSE 100	+0.6
US: S&P 500	-11.4
Australia: Current at 1 July 2022
$AUS: $US	0.68
Official interest rates (%)	0.85
10-year bond yield (%)	3.59

Published : 18 Jul 2022