The green shoots of higher prices
The most recent quarterly CPI numbers (March 2021) showed inflation rose by only 1.1% over the past year. The economy is in the process of recovering from the biggest slowdown since the Great Depression, so the number was never going to be huge. Indeed, modest inflation rises has been a feature in most developed countries over the early months of 2021.
The bigger picture is that right now the economy is experiencing a period where demand for many goods and services is outstripping supply. It is widely viewed that this will be temporary. Demand is high partially because households are making up for lost spending last year. In time this make-up demand could settle back towards a more ‘normal’ growth of spending.
COVID-related restrictions are impinging on supply globally. Government restrictions on economic activity and closed borders (or the threat of them being closed) is limiting worker mobility. This makes it difficult for firms to operate at maximum capacity. According to a recent ABS survey, 30% of firms indicated they faced supply-chain problems (and 37% of those were severely impacted). The sectors reporting the biggest problems were manufacturing, wholesale and retail trade, and other services (such as auto-repair shops).
The hope is that the vaccine rollout will in time lead to reduced restrictions and more open borders. This should help boost supply of goods and services.
The RBA: No change, but for how long?
Recently we found out that the RBA kept monetary policy unchanged. Once upon a time that meant there was no change in interest rates (the cash rate was kept at 0.1%). But these days it means looking at a wider range of policies. This includes cheap funding to banks (previously announced to finish at the end of June).
The RBA also has two other programs to help the economy. One is Quantitative Easing (QE) where the RBA buys long-term Government bonds to reduce interest rates. The other is Yield Curve Control (YCC) where the RBA pegs the 3-year government yield at 0.1% to help keep short-term rates to the wider economy low. The RBA announced that they will decide at their July meeting whether to extend these two policies.
The Budget – Letting the good times roll
Plenty of good things come from a stronger economy. One of them is that it does good things for the Government’s budget. Lower unemployment means less spending. More jobs and profit growth mean higher taxes. The Budget deficit will be clearly lower than what had been predicted at budget time. We will soon find out how much lower.
The Government has copped criticism for not doing enough pre-COVID to get the economy humming. The unemployment rate was 5% but the economy was widely (and justifiably) thought to be just so-so. The RBA means to make sure the economy is travelling better than its pre-COVID speed. And so does the Government. This means that some of the better budget outcomes will be banked (reducing the deficit). But some will be spent. There has been less discussion about lower taxes.