Rate rise all but guaranteed after inflation jump

Treasurer Jim Chalmers will have to find spending cuts on top of potentially unpopular economic reforms in his May budget after a jump in inflation all but guaranteed the Reserve Bank will inflict higher interest rates on home borrowers within days.

Financial markets and most economists believe the bank will use its first meeting of the year on Monday and Tuesday next week to lift the official cash rate by a quarter percentage point to 3.85 per cent in a bid to dampen inflation pressures.

The increase on a $600,000 mortgage would add almost $100 to a household’s monthly repayments.

The December consumer price index released on Wednesday by the Australian Bureau of Statistics showed prices increased by a full percentage point last month, taking the annual rate to 3.8 per cent.

The lift was driven by electricity prices which, at an annual rate, grew by 21.5 per cent over the year compared to 19.7 per cent in the 12 months to November. The end of generous power subsidies in both Queensland and Western Australia contributed to the lift.

But in a sign the economy is running strongly, airlines were able to push up their fares during the Christmas period. Domestic holiday prices lifted by 8.2 per cent, in part due to the Ashes Test series, while international travel costs soared by 24.4 per cent, the largest monthly jump since pandemic restrictions on travel ended in 2023.

Of concern to the Reserve Bank, underlying inflation rose for the second successive quarter by 0.9 per cent, taking the annual rate to 3.4 per cent, its highest level since late 2024. The bank had expected it to be at 3.2 per cent.

Chalmers, who will deliver his fifth budget in early May, admitted inflation was higher than he would like and accepted it was his responsibility to put downward pressure on prices.

This year’s budget had been expected to be dominated by the government’s reform agenda, drawn from last year’s economic roundtable and a suite of reports on possible policy changes identified by the Productivity Commission. But Chalmers said inflation would also be central to the budget.

“My job is to focus on this inflation, the productivity challenge and this global uncertainty. Those will be the three key influences on the budget that Katy Gallagher and I release in May,” he said.

“I take responsibility for doing my job to address this inflation challenge in our economy, to address the productivity challenge in our economy, and also to do what we can to make our economy more resilient in the face of all this global economic uncertainty.”

In his mid-year update released last month, Chalmers forecast cumulative deficits of $143.3 billion between this year and 2028-29.

This year’s deficit, revised down to $36.8 billion, is likely to come in smaller due to the ongoing strong jobs market and higher-than-expected commodity prices. But it is still on track to show the government spending more than it is receiving in revenues.

Shadow treasurer Ted O’Brien said the poor result was purely due to Chalmers and government spending.

“This government is competing with everyday Australians for goods and services, pushing up the price of everything. This renewed inflation will further erode real wages, increase income tax burdens and add pressure to interest rates,” he said.

Some price pressures remain out of the control of both the government and Reserve Bank.

Beef and lamb prices rose by 10 per cent through the year due to strong demand from the United States.

Fruit and vegetable prices rose by 4 per cent, up from 2.7 per cent in September. The bureau said shortages of cucumbers, zucchinis, capsicums and apples caused by poor weather were key factors for higher prices.

Deloitte Access Economics partner Stephen Smith said the fact inflation was increasing while the economy was experiencing modest growth suggested Australians’ living standards were at risk without policy change.

“Whether the economy is at capacity or not will become clearer over the coming months. But if this is really as good as it gets for economic growth, then Australia has bigger problems than an interest rate increase,” he said.

AMP economist My Bui said given the Reserve Bank’s strong recent commentary about bringing inflation under control, there was little prospect that mortgage holders would escape unscathed from next week’s RBA meeting.

“The Reserve Bank will have little choice but to hike rates in its upcoming February meeting,” she said.

The RBA cut interest rates in August. A rate increase next month would be one of the bank’s fastest changes in monetary policy direction.

Emerging from the global financial crisis in 2009, ahead of the crisis in 2007 and after the September 11 attacks, the bank reversed interest rate movements within six months.

KPMG chief economist Brendan Rynne cautioned the inflation figures were still being disrupted by the end of electricity subsidies while the surge in holiday travel through December was unusually high and would be reversed in coming months.

“With employment growth now only running at around 1.2 per cent per annum, and market sector employment over the past 12 months to November actually negative, the RBA will need to be cautious it doesn’t pull the rug out from under the private side of the economy,” he said.

Economists at the ANZ, who had expected the Reserve to hold interest rates steady next week, now believe it will push the cash rate up to 3.85 per cent.

Senior ANZ economist Adelaide Timbrell, however, noted that the bank was likely to hold steady for an extended period as the inflation report suggested price pressures may be about to ease.

Some of that will come from a stronger Australian dollar which on Wednesday climbed above US70¢ for first time in three years on expectations of a lift in interest rates here and weakness in the US economy.

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