Financial markets suffer heavy falls amid rumblings inflation and interest rates could ratchet up again
Concerns are emerging that financial markets and households need a reality check when it comes to the outlook on inflation and interest rates.
Most economists agree central banks, including Australia’s Reserve Bank, are making solid progress in achieving their inflation goals.
The RBA’s goal is to achieve headline inflation of between 2 and 3 per cent, on average, over time.
The thinking among analysts and economists, however, is that even if central banks achieve their inflation goals, the pace of price increases could once again turn up.
“It’s not my base case, but you can’t dismiss the possibility,” independent economist Saul Eslake said.
He’s primarily concerned about the demand generated by the implementation of the stage 3 tax cuts if the Reserve Bank sees fit to cut interest rates later this year, as many economists are forecasting.
“Were the Reserve Bank to start cutting interest rates according to [the] financial markets’ timetable — bearing in mind that households are already going to get, come the first of July, tax cuts that in aggregate are the equivalent of two [quarter-of-a-percentage-point] reductions in interest rates — it’s not implausible that inflation, particularly of services, could pick up again,” he said.
But Mr Eslake sees inflationary pressures emerging elsewhere too — in the near term, for example, from the rebound in shipping costs caused by Houthi rebels’ attacks on vessels passing through the Red Sea.
“You can also see it coming from the fact the US economy in particular has been incredibly resilient in the face of the Federal Reserve’s increases in 2022 and 2023, so if the Fed was to do as markets expect and start cutting interest rates in June this year … the US economy and US inflation could [rise] more strongly than the Fed is currently contemplating,” he said.
Mr Eslake isn’t the only one cautioning on the prospect of a rebound in inflation later this year.
New York-based asset management firm BlackRock manages roughly $US10 trillion ($15 trillion) for clients, so when its key strategist talks, investors listen.
Global chief investment strategist Wei Li told the Australian Financial Review Business Summit that despite the progress that had been made to reduce global inflation, keeping it within the bounds accepted by most central banks might be challenging.
“In the long term, markets may not be appreciating how different the new regime is in terms of the supply-side constraints,” she said.
She referred to new and ongoing supply chain constraints, shifting geopolitical risks and an aging global population — all of which, she said, could lift inflation over the next three to five years.
“Three is the new two in this environment,” she said, in reference to a perceived risk that central banks might need to accept an inflation rate with a “three” rather than a “two” in front of it.
‘That rally was getting a bit tired’
Financial markets, including share markets, have experienced record-breaking runs in recent weeks on the expectation that the worst of inflation has passed and lower interest rates are imminent.
On Monday, the Australian and Japanese share markets experienced sharp falls.
Henry Jennings, a senior market analyst for the Marcus Today financial newsletter, noted the share markets were “due for a sell-off” after experiencing record highs.
He said investors were “taking profits”, with banking and resources stocks seeing the biggest price drops.
“[The] banks got a little silly and iron ore [is] down in Asian trade,” he said.
That was a reference to bank stock prices being way above what analysts would consider to be fair value, and lower commodities prices weighing on the valuation of resources companies.
Other analysts said there was nothing obvious to spark today’s heavy selling.
“I don’t see any obvious catalyst at the moment, but that rally was getting a bit tired, to be honest,” Angus Coote, head of investments at Jamieson Coote Bonds, said.
Costello warns against making assumptions about rates
Former treasurer Peter Costello, also speaking at the AFR’s summit on Monday, noted that financial markets across the world had priced in ongoing materially lower interest rates, and that presented a risk.
“What happens if they don’t materialise as soon as the market expects?” he asked.
“There is a fair bet to make that the market may have run beyond itself.”
But Mr Coote said all evidence was pointing to lower inflation and lower interest rates in the near term.
“We are in a per capita recession,” he said. “The economy is weak, no question.”
However, he conceded “the last mile of inflation”, namely bringing it within the RBA’s 2 to 3 per cent band, would be challenging.
All eyes will be on US February inflation figures, due out Monday night Australian time, to see if the world’s biggest economy has made any further progress on bringing the pace of price increase under control.
