Australia is seeing mortgage stress and other cost-of-living pressures rise, but we can avoid the financial impact being felt in the UK and US, says a UNSW Business School real estate expert

A perspective on the national economy, inflationary pressures, interest rates, house prices, household budgets and cost of living......

UNSW, media release, 7 November 2022:

What happens to the economy if you can't pay your home loan?

Australia is seeing mortgage stress and other cost-of-living pressures rise, but we can avoid the financial impact being felt in the UK and US, says a UNSW Business School real estate expert.

For economists – and indeed, anyone else with an interest on how much they spend at the supermarket – cost-of-living and housing prices have been hot topics in 2022. The Reserve Bank of Australia (RBA) has been trying to combat rising inflation with interest rate raises (read how that works here).

The latest rise was announced by the RBA last week on November 1, with the official cash rate rising to 2.85 per cent.

This process has contributed to a fall in house prices in some areas, as well as fears from mortgage holders that they won't be able to make payments on the now larger amounts.

“Australians have been fortunate to see sustained house price growth for a while now,” says economist and expert in real estate markets, Dr Kristle Romero Cortés Associate Professor in the School of Banking & Finance, UNSW Business School. “But they need to know, house prices can come down too.”

But while data from the Domain Group (shares of which are majority owned by Nine Media) might have recently shown the sharpest quarterly decline in house prices since 1994 across the country’s biggest capital cities, Dr Romero Cortés isn’t unduly concerned about house price falls.

“Commentary on the housing market is quite sensationalised in the media.”

But when it comes to not being able to pay the mortgage, and the impact higher loan repayments might have on the economy? That’s a bit more complicated to predict.

Why Australia may not follow other countries into financial disaster

Australians only have to look over to the United Kingdom to feel nervous when witnessing the impact of high inflation and interest rates on the economy and the day-to-day lives of financial situation of its citizens.

Like Australia, the UK’s central bank (the Bank of England) has introduced a series of interest rate hikes that have had a limited effect. Unlike Australia, the UK economy is still reeling from Brexit, plus a post-pandemic recovery, high inflation and energy costs, and levels of wage stagnation that have seen various sections of the working population strike.

The country has also just experienced the effects of a disastrous set of economic policies and extensive tax cuts for the wealthy implemented by Liz Truss as prime minister, which would have put money into in an already inflated economy (where the idea is to usually ‘cool’ things by encouraging people not to spend).

This spooked the financial markets to such a degree that investors quickly sold off British assets, including government bonds. The value of the pound plunged, forced the Bank of England to take an unprecedented step and pledge 65 billion pounds worth of bonds to stop pension funds from failing and stabilise the market … and caused Liz Truss to resign after just 44 days.

For the average Briton, this situation has led to a greater threat of recession: something which could lead to loss of jobs, higher unemployment, higher inequality, wage growth that is too low to match price increases, and issues meeting costs, such as regular mortgage payments that have already risen because of interest rate hikes.

But does the UK situation foreshadow D-R-A-M-A for the Australia’s own economy and housing market? Dr Romero Cortés says no – for several reasons.

Australians are fans of variable rate loans - unlike in the UK

As well as not experiencing a Brexit-like crash or an energy price crunch to the same degree, a big point of difference is that Australians are more likely to have opted for the more flexible variable rate mortgages, than in the UK, where homeowners are more likely to have picked fixed rate mortgage.

In the UK, 74 per cent of homeowners have a fixed rate mortgage for their home loans, and 96 per cent have chosen this option since 2019, according to data from UK-based trade association, UK Finance. AMP Capital data shows that Australia has a higher share of mortgage holders with variable rate mortgages. Just 10-15 per cent picked fixed rates before 2020 (although this rose to 40 per cent in 2020-2021).

While variable rate mortgages can be a great option when interest rates are low in the short-term, fixed rate mortgages can be more predictable over the long-term, as they are less impacted by interest rate rises that can raise overall home loan repayments.

“What we see in the US or Europe is not necessarily what we will see here,” Dr Romero Cortés says. “The US Federal Reserve (Fed) or the Bank of England are also effectively trying to slow down the economy, but when they raise their rates, they can't reach a large portion of homeowners that have a 30-year fixed rate mortgage.

“The Fed and the Bank of England can raise cash rates all they want – they are not reaching these homeowners.

“In Australia, our increases from the RBA pass through the banks almost instantaneously to the consumers,” she explains. “There is a slight delay because banks want to give borrowers as much time as possible to budget in an increase, but that rate does flow through almost automatically in a way that's much faster here than you'll see in countries like the US and UK.”

This means, faster possible cooling impacts on the economy with the RBA puts interest rate hikes in place.

Another big factor is that the big four Australian banks are highly capitalised.

“They are flush with cash,” explains Dr Romero Cortés. “I study the financial network in Australia, and it is very sound. We won’t see the kind of crisis that we saw in the US in 2008, where the banks were holding assets that they didn't understand the underlying worth of.”

What does that mean for mortgage stress and the Australian economy?

Dr Romero Cortés say that while lifting of interest rates might mean Australia will see mortgage stress rise faster than in other places, it is this situation that helps the RBA prevent the economy from “running red hot” and collapsing in on itself.

“Like any central bank, the RBA wants to ensure price stability, and they will do whatever it takes to prevent us from losing this. They don’t want consumables like bread and eggs to suddenly be seven times as much the next day. If that happens people will revolt, effectively.

“We're nowhere near there. But that's why we don't want to get anywhere near there. So, the RBA stay very much on top of this, and their role is to keep this issue as front and centre of the Australian public for as long as they need, so they are more cautious with their spending over a longer period of time.”

It’s in this way that the RBA plays a psychological stabilising role, not just a financial one.

“You know, ‘Okay, the RBA is on this: so, I don't need to freak out’,” says Dr Romero Cortés. “Because if you as a member of the financial public start freaking out, you’re more likely to make poor financial decisions which have more of a domino effect on the wider economy.”

Having said that, there is a limit to how much financial stress homeowners can undergo.

"There could be a point where homeowners and others can't withstand the raising of monthly repayments any longer,” she says. “This is not yet the case.

“Long term, you would expect some sort of horizon where things settle around 4 or 5 per cent cash rate. Australia is highly leveraged (meaning it has an on average high level of debt to equity), so more than that would be difficult to sustain.”

Banks don’t want to see mortgage defaults

At the end of the day, lenders don’t want homeowners to default on loans or to proceed with a repossession. It’s costly, in time, effort and capital for them, says Dr Romero Cortés. They would much rather work with the borrower before they get to that point of extreme financial difficulties.

“A homeowner in financial stress would contact your bank, who would require some documentation of financial hardship, and then would work with you either in a payment plan or deferral plan, refinancing or making interest-only payments.”

Remember: you're not getting out of it. You still pay it, the interest is still accruing, and it could lengthen the loan term. All this means that borrowers are going to consume less in other places, and therefore is supposed to lead to a ‘cooling’ of the economy.

What happens if cost of living doesn’t come down?

But if living here gets too hard and expensive with inflation or higher mortgage repayments, you could see Australia reputation as ‘a good place to live’ take a hit, pushing down the number of people who want to live here, and putting further pressure on an already tight labour market, says Dr Romero Cortés.

For example, a portion of all the Australians with overseas heritage might decide Australia is too hard and expensive to live in and move to their other country of citizenship. That’s when it might start to get uncomfortable.

"Australia has an economy that's built up by people wanting to come to Australia, and we’re constantly growing in that fashion,” explains Dr Romero Cortés. “There's demand for housing, education, and we currently have people willing to come here.

“So, the government can say whatever they want about the RBA [and their decision to raise rates] so they will get voted in again. But the RBA doesn’t have a choice: one family defaulting on their mortgage, compared to everyone not being able to afford bread, is what they are envisioning.”

Does all this mean house prices will come down more?

Higher mortgage repayments could pressure homeowners to accept lower sale prices than they might have expected from their property, investment or otherwise; nudging down overall prices on the property market over a period of time, as well as the occasional ‘fire sale’.

“Are you going to see a massive crash of house prices where you see a Bondi four-bedder going for $500,000? No.

“But we could see a small depression in prices where 5 to 10 per cent of the price is cut. Even if you cut off 10 per cent from a $2 million home, that's $200,000 less. This means unless they have to, sellers are not going to want to sell.”

All this means it is true you're going see some very high mortgage payments and additional cost of living pressures as homeowners prioritise their mortgage repayments, Dr Romero Cortés points out.

“It’s also true that politicians (who are complaining about the RBA’s approach) may be among those who own a lot of investment properties themselves.”

Dr Kristle Romero Cortés is an Associate Professor in the School of Banking & Finance in the Business School at UNSW Sydney, an expert in real estate economics and formerly worked at the Federal Reserve Bank of Cleveland.

Tweet of the Week

WHO WOULD HAVE THOUGHT that a big part of the reason why prices have gone up so much & wages are kept down is because big business has so much power in our country they can get away with both!!! It seems the RBA is finally saying it out aloud. Price gouging & wage suppression.

— Sally McManus (@sallymcmanus) September 16, 2022

 

Tweets of the Week

The gas industry lobby group APPEA have put some ads on social media boasting about how much tax and royalties the gas industry pay.

Here's what they don't tell you.

Climate & Energy Principal Advisor @MarkOgge explains. #auspol pic.twitter.com/6WFafdobkZ

— Australia Institute (@TheAusInstitute) July 25, 2022

With inflation now running at 6.1% annually & wage growth at only 2.4% we have moved from the era of wage stagnation to the new era of cuts to real wages.

— Josh Bornstein (@JoshBBornstein) July 27, 2022

Consumer Price Inflation now stands at 6.1% in the 12 months to end of June 2022 in Australia - rising 1.8% in the June Quarter

 

Australian Bureau of Statistics (ABS), media release, 27 July 2022:

SOURCE: Consumer Price Index, Australia, June 2022

The Consumer Price Index (CPI) rose 1.8 per cent in the June 2022 quarter and 6.1 per cent annually, according to the latest data from the Australian Bureau of Statistics (ABS).

Head of Prices Statistics at the ABS, Michelle Marquardt, said "The quarterly increase of 1.8 per cent was the second highest since the introduction of the Goods and Services Tax (GST), following on from a 2.1 per cent increase last quarter."

The most significant contributors to the rise in the June quarter CPI were new dwellings (+5.6 per cent) and automotive fuel (+4.2 per cent).

"Shortages of building supplies and labour, high freight costs and ongoing high levels of construction activity continued to contribute to price rises for newly built dwellings. Fewer grant payments made this quarter from the Federal Government's HomeBuilder program and similar state-based housing construction programs also contributed to the rise," said Ms Marquardt.

"The CPI's automotive fuel series reached a record level for the fourth consecutive quarter. Fuel prices rose strongly over May and June, following a fall in April due to the fuel excise cut."

The price of goods (+2.6 per cent) continued to rise more strongly than that of services (+0.6 per cent). Notable rises were recorded across the food group (+2.0 per cent) and the furnishings, household equipment and services group (+2.5 per cent). Main contributors to the rise in food prices included vegetables (+7.3 per cent), meals out and takeaway foods (+1.4 per cent), and fruit (+3.7 per cent). Supply chain disruptions due to flooding events, labour shortages, and rising freight costs contributed to higher prices. Furniture prices rose (+7.0 per cent) due to increased transport and material costs, and stock shortages.

Services recorded a smaller rise compared with goods. Financial services (+1.2 per cent) and holiday travel and accommodation (+2.3 per cent) rose. Child care (-7.3 per cent) fell as the full effect of additional child care subsidies for families with two or more children under the age of 6, which commenced on 7 March, flowed through into this quarter. Before and after school care vouchers offered by the NSW Government also contributed to the fall in child care costs. Urban transport fares (-4.4 per cent) fell due to free travel periods introduced by the NSW and Tasmanian State Governments within the quarter.

Annually, the CPI rose 6.1 per cent, with new dwellings (+20.3 per cent) and automotive fuel (+32.1 per cent) the most significant contributors.

"The annual rise in the CPI is the largest since the introduction of the goods and services tax (GST)."

"Annual price inflation for new dwellings was the strongest recorded since the series commenced in 1999," said Ms Marquardt.

Underlying inflation measures reduce the impact of irregular or temporary price changes in the CPI. Trimmed mean inflation increased to 1.5 per cent over the quarter and 4.9 per cent over the year. The price of goods (+8.4 per cent) continued to rise more strongly through the year than that of services (+3.3 per cent).

"Annual trimmed mean inflation was the highest since the series commenced in 2003 and annual goods inflation was the highest since 1987, as the impacts of supply disruptions, rising shipping costs and other global and domestic inflationary factors flowed through the economy," said Ms Marquardt.

~~~~~~~~~~~~~~~~~~~~~~~~

https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/consumer-price-index-australia/jun-2022

"In the earnings reports, companies have bragged about how they have managed to be ahead of the inflation curve, how they have managed to jack up prices more than their costs and as a result have delivered these record profits"

“Australia isn’t experiencing a wage-price spiral, it’s at the beginning of a price-profit spiral,” said Australia Institute chief economist, Dr Richard Denniss.

“The national accounts show it is rising profits, not rising costs, that are driving Australia’s inflation. While workers are being asked to make sacrifices in the name of controlling inflation, the data makes clear that it is the corporate sector that needs to tighten its belt.”

The report points out that wage growth was at record low levels, while the profit share was at a near-record share of GDP.” 

[The Guardian, 18 July 2022]

Corporations are causing inflation by passing on price increases. They are doing this to protect and grow their profits, the same reason why they are refusing decent wage rises https://t.co/1imWMHBBEA

— Sally McManus (@sallymcmanus) July 17, 2022

The Australia Institute, Are wages or profits driving Australia’s inflation? An analysis of the National Accounts, July 2022, excerpts:

Introduction

In recent months the role of wages in driving inflation has been frequently discussed, with many commentators expressing concern that Australia risks a ‘wage price spiral’.

For example:

“Aggressive wages growth will only spur further inflation growth.”

— Andrew Mackellar, CEO of the Australian Chamber of Commerce and Industry

“We are now at risk of a wages and inflation and interest rates death spiral.”

— Innes Willox, CEO of Australian Industry Group

“In the current circumstances, there is a clear risk that a high increase in wages without improved workplace productivity would fuel inflation and increase the likelihood of a steeper rise in interest rates to the detriment of growth and job creation.”

— Innes Willox, CEO of Australian Industry Group

The fear that wage growth has, or could, play a significant role in Australia’s inflation typically ignores the fact that, as shown in Figure 1, real wage growth is at historically low levels and has been for some time.

While wage growth clearly has not been the driving force of recent increases in Australian inflation, or indeed inflation around the world, the continuing impact of COVID 19 and the sharp increase in global energy prices associated with Russia’s invasion of the Ukraine clearly have.

What causes inflation?

Inflation refers to an overall increase in the level of prices in an economy. According to the International Monetary Fund:

Inflation is the rate of increase in prices over a given period of time. Inflation is typically a broad measure, such as the overall increase in prices or the increase in the cost of living in a country.

While much is made of the link between increases in the costs of inputs (such as the price of oil) and increases in prices (such as the price of petrol) in fact many firms have a high degree of discretion about how much, if any, of an increase in costs they will pass on in the form of higher prices.

In short, if firms choose to absorb all of an increase in cost rather than increase prices the cost increases will lead to a reduction in profit not an increase in prices. Similarly, if firms pass on price increases that are more than enough to cover an increase in their production costs then profits will rise. In turn, macroeconomic data on economy-wide changes in prices and the share of GDP flowing to workers and profits can shed light on both the underlying sources of inflation and the distributional consequences of firms’ responses to rising production costs.

While spokespeople for large companies often suggest they have ‘no choice’ but to increase their prices when their costs increase not only do they have the choice to accept lower profits, a closer examination of their language makes clear that they face a range of choices.

For example, in attempting to explain how he had ‘no choice’ but to increase prices in his stores in early 2002, Gerry Harvey, the Executive Chairman of the retail chain Harvey Norman, actually made clear the range of choices he did face:

If a guy down the road drops the price, we drop the price,

If we drop the price, they drop the price.

But if it’s costing you all 10 per cent more than it was yesterday, they’re all going to put up their prices (because) they’ve got no choice.

Mr Harvey makes clear that his company is willing and able to choose to lower prices to match his competitors pricing, even in the absence of a change in cost. He also makes clear that he expects other firms not to absorb any increase in costs and that his firm and his competitors are all likely to increase their prices if costs increase by 10 percent, but it is not clear by how much his firm, or others, would chooses to increase their prices by.

Intriguingly, he ends this explanation by saying firms have no choice, even though all firms have different costs structures and his opening statement is that he would lower his price to match a cheaper offer by a competitor.

As all firms have slightly different cost structures, contract terms for inputs, bottoming costs and exposures to market rents it is inconceivable that all firms in any industry would experience identical changes in price and, in turn, the choices firms make about their price setting in response to changes in cost reflect both their current rates of profit and their willingness to gain or lose market share…..

In short, while in the long run firms must set prices sufficient to cover their costs of production, there is no direct link between costs of production and prices beyond the desire of firms to maintain, or increase, their profits. While firms in new industries seeking rapid growth often deliberately set their prices below their costs in, companies like Santos are currently enjoying a significant increase in price that is entirely unrelated to their cost of production.

Given that profits currently account for a record share of GDP there is simply no truth behind the assertion that the Australian corporate sector has ‘no choice’ but to pass on cost increases in full in the form of higher prices. Indeed, the rising profit share of GDP suggests that Australian firms have, for some time, been choosing to increase their prices faster than their costs have been rising. By definition this causes higher inflation…..

The European Central Bank’s analysis of the role of profits in driving inflation

In a recent speech, Isabel Schnabel, a member of the board of the European Central Bank, said “profits have recently been a key contributor to total domestic inflation” ……

Ms Schnabel went on to state that:

many firms have been able to expand their unit profits in an environment of global excess demand despite rising energy prices… The resilience of profits is particularly evident in those sectors most heavily exposed to global conditions, such as the industry and agricultural sector.

And:

To put it more provocatively, many euro area firms, though by no means all, have gained from the recent surge in inflation. The fortunes of businesses and households have diverged outside of the euro area, too, with corporate profits in many advanced economies surging over the past few quarters.

Poorer households are often hit particularly hard – not only do they suffer from historically high inflation reducing their real incomes, they also do not benefit from higher profits through stock holdings or other types of participation.…..

Australian results

The methodology used by the ECB to decompose recent shifts in price levels and attribute them to shifts in wages, profits and taxes can be applied to Australian data to show the contribution of each to inflation.

The Australia Institute applied the ECB method to annual data for the financial years 2005 to 2021 and quarterly data for June 2021 to March 2022 (the most recent quarter for which data is available). Annual data was used where possible to minimise the volatility in the underlying data caused by COVID-19 support payments affecting tax and subsidies.

The Australian data provides even more stark results than the ECB’s. Figure 5 shows that unit labour costs played almost no role in inflation (as measured by the GDP deflator) over the period 2013 to 2021 and had typically contributed less than half of the GDP deflator prior to 2013.

For the three quarters of data available for 2021–22, encompassing the current uptick in the CPI, labour costs have played an insignificant role, accounting for only 0.6 percentage points of the 4.1 percentage point increase in the GDP deflator (15 percent of the total).

Meanwhile profits have accounted for 2.5 percentage points of the increase in the GDP deflator (about 60 percent of the total).…..

Read the full 15 page report here.

Billionaire business owners and industry lobbyists have other ways of saying our profits are more important than people without ever mentioning the word. Here is a recent example.

ABC News, 17 July 2022:

Head of the Victorian Chamber of Commerce and Industry, Paul Guerra, welcomed the announcement but said the government must ensure it keeps the balance between supporting people in need and running the economy into debt.

"The federal government has told us the pandemic is not over," Mr Guerra said.

"The current wave seems to be stronger than we might have all first thought so we think it's a good thing that support is being provided there for those who are in need.

"That said, we'd like to make sure they come off as soon as the current risk is over so we can accelerate our way as we recover out of COVID."

BACKGROUND

Across the board record profit taking is not just an Australian phenomenon….

Political economist Assistant Professor Isabella M. Weber speaking on U.S. NPR radio program "All Things Considered", 13 February 2022:

Companies always want to maximize profits, right? In the current context, they suddenly cannot deliver as much anymore as they used to. And this creates an opening where they can say, well, we are facing increasing costs. We are facing all these issues. So we can explain to our customers that we are raising our prices. No one knows how much exactly these prices should be increased. And everybody has some sort of an understanding that, oh, yeah, there are issues, so, yes, of course companies are increasing prices in ways in which they could not justify in normal times.

But this does not mean that the actual amount of price increase is justified by the increase in costs. And as a matter of fact, what we have seen is that profits are skyrocketing, which means that companies have increased prices by more than cost. In the earnings reports, companies have bragged about how they have managed to be ahead of the inflation curve, how they have managed to jack up prices more than their costs and as a result have delivered these record profits. [my yellow highlighting]

Cartoons of the Week

Fiona Katauskas

David Rowe

John Shakespeare

 

Fiona Katauskas

Australia's Reserve Bank signals that inflation is expected to increase beyond the 5.1% rise recorded for the twelve months to March Quarter 2022 - 5 weeks after initially raising its cash rate target the Bank raised the rate for a second time on 7 June 2022

 

On 3 May 2022 the Reserve Bank announced that due to a stronger than expected rise in the inflation rate, measures were being undertaken to reduce inflationary pressure. 

Put simply, monetary policy indicated a need to drive the current inflation rate from 5.1% down to somewhere between 2-3% to keep basic cost of living increases within manageable limits and the national economy stable.

In order to begin this process the Board decided to increase the cash rate target by 25 basis points to 35 basis points. It also increased the interest rate on Exchange Settlement balances from zero percent to 25 basis points.

This translated into a cash rate of 0.34% and an exchange settlement balance interest rate of 0.25%.

On 7 May the Reserve Bank moved again - raising the cash rate to 0.85% and the exchange settlement balance interest rate to 0.75%.

If inflation continues to rise in the second half of this year it is possible that the Reserve Bank will increase the cash rate target to est. 1.25% by the end of December 2022. There is some speculation in business/financial media that the cash rate target might go as high as 2.5% sometime in 2023 before it begins to fall.

Commercial banks will likely be reassessing their lending rates in the coming weeks. The four big banks - Westpac, CBA, ANZ and NAB - have already responded with variable home loans increasing by 0.5%. That increase comes into effect from 17 June (CBA, ANZ, NAB) and 21 June 2022 (Westpac). 

By way of example, this increase is likely to add around $115 per month on a $450,000 home loan where the homeowner is making a scheduled principal and interest payment. 

~~~~~~~~~~~~~~~~~~~~

Reserve Bank of Australia

Media Release

Statement by Philip Lowe, Governor: Monetary Policy Decision

Number 2022-14

Date 7 June 2022

At its meeting today, the Board decided to increase the cash rate target by 50 basis points to 85 basis points. It also increased the interest rate on Exchange Settlement balances by 50 basis points to 75 basis points.

Inflation in Australia has increased significantly. While inflation is lower than in most other advanced economies, it is higher than earlier expected. Global factors, including COVID-related disruptions to supply chains and the war in Ukraine, account for much of this increase in inflation. But domestic factors are playing a role too, with capacity constraints in some sectors and the tight labour market contributing to the upward pressure on prices. The floods earlier this year have also affected some prices.

Inflation is expected to increase further, but then decline back towards the 2–3 per cent range next year. Higher prices for electricity and gas and recent increases in petrol prices mean that, in the near term, inflation is likely to be higher than was expected a month ago. As the global supply-side problems are resolved and commodity prices stabilise, even if at a high level, inflation is expected to moderate. Today's increase in interest rates will assist with the return of inflation to target over time.

The Australian economy is resilient, growing by 0.8 per cent in the March quarter and 3.3 per cent over the year. Household and business balance sheets are generally in good shape, an upswing in business investment is underway and there is a large pipeline of construction work to be completed. Macroeconomic policy settings are supportive of growth and national income is being boosted by higher commodity prices. The terms of trade are at a record high.

The labour market is also strong. Employment has grown significantly and the unemployment rate is 3.9 per cent, which is the lowest rate in almost 50 years. Job vacancies and job ads are at high levels and a further decline in unemployment and underemployment is expected. The Bank's business liaison program continues to point to a lift in wages growth from the low rates of recent years as firms compete for staff in a tight labour market.

One source of uncertainty about the economic outlook is how household spending evolves, given the increasing pressure on Australian households' budgets from higher inflation. Interest rates are also increasing. Housing prices have declined in some markets over recent months but remain more than 25 per cent higher than prior to the pandemic, supporting household wealth and spending. The household saving rate also remains higher than it was before the pandemic and many households have built up large financial buffers. While the central scenario is for strong household consumption growth this year, the Board will be paying close attention to these various influences on consumption as it assesses the appropriate setting of monetary policy.

The Board will also be paying close attention to the global outlook, which remains clouded by the war in Ukraine and its effect on the prices for energy and agricultural commodities. Real household incomes are under pressure in many economies and financial conditions are tightening, as central banks withdraw monetary policy support in response to broad-based inflation. There are also ongoing uncertainties related to COVID, especially in China.

Today's increase in interest rates by the Board is a further step in the withdrawal of the extraordinary monetary support that was put in place to help the Australian economy during the pandemic. The resilience of the economy and the higher inflation mean that this extraordinary support is no longer needed. Given the current inflation pressures in the economy, and the still very low level of interest rates, the Board decided to move by 50 basis points today. The Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead. The size and timing of future interest rate increases will be guided by the incoming data and the Board's assessment of the outlook for inflation and the labour market. The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time. [my yellow highlighting]

Climate change, distant war & a continuing global pandemic are all impacting on household budgets and business in Australia right now

With La Niña conditions expected to continue above average rainfall over Winter months, higher commercial and residential electricity prices to be reflected in quarterly bills sometime after 1 July 2022, petrol prices at the pump making life harder for small business and households alike, food prices rapidly rising and the loss of commercial passenger flights to Lismore and Grafton airports with a significant reduction in flights to Ballina, Northern Rivers residents are going to have to dig a little deeper to find that fortitude the region’s communities are known for.

BACKGROUND

ANZ Research, Agricultural Insight, 31 May 2022. “Global Food Crisis To Worsen”, exceprt:

Bringing it home

Food shortages are expected to worsen as climatic issues, energy shortages, the pandemic and the invasion of Ukraine all impact the world’s ability to produce sufficient food. China appears to be one step ahead of the rest of the world in terms of securing additional food supplies. Their policy to increase their reserves of imported products is now serving them well as other countries scramble to import product at inflated prices.

High global food prices will cause hunger in developing nations and erode wealth globally, as it will continue to underpin inflation. Food-exporting nations like Australia and New Zealand may continue to benefit in a net sense from high commodity prices, but it’s hard going for lower-income earners. In addition, as global prices become too expensive, demand will fall, as consumers’ ability to purchase higher-value proteins such as dairy products and red meats is reduced. Demand for basic foodstuffs such as grains is not expected to wane to the same extent – people have to eat.

Therefore the world will need to wait for global supply to increase before these markets rebalance and prices temper.

It’s also worth noting that high food prices are not conducive to geopolitical stability. Hunger induces migration and topples governments. The food crisis is another factor to add to the growing list of potential geopolitical risks as the world tentatively emerges from the shadow of COVID-19. [my yellow highlighting]

Australian Bureau of Statistics (ABS), Consumer Priece Index: March Quarter 2022, 27 April 2022:

• The Consumer Price Index (CPI) rose 2.1% this quarter.

• Over the twelve months to the March 2022 quarter, the CPI rose 5.1%.

• The most significant price rises were New dwelling purchase by owner-occupiers (+5.7%) and Automotive fuel (+11.0%)….

Food and non-alcoholic beverages rose by 2.8% since the previous December 2021 quarter and 4.3% since March Quarter 2021. Health prices also rose 2.3% since the previous quarter and 3.5% since March Quarter 2021. Education prices went up by 4.5% since the previous quarter and 4.7% since March Quarter 2021. Housing prices rose by 2.4% from the previous quarter and 6.7% since last year’s March quarter. While Transport prices rose 4.2% since the previous quarter and a whopping 13.7% since last year’s March quarter.

With the exception of Clothing and footwear every CPI benchmark rose since the previous quarter.

The Guardian, 1 June 2022:

Australia is set for its third bumper season of crops in a row, but the increased production will probably bring little relief at the cash register as rising global demand pushes prices skyward.

Australian farmers will plant an area almost the size of England this winter as they try to take advantage of soaring global food prices and a third year of good rains.

The quality of production, though, may be hit by waterlogged fields and reduced fertiliser use as those costs surge, according to Rabobank. Local manufacturers, too, say they’re under strain as raw material and other prices climb and not all of the increases can be passed on.

This winter, farmers will plant a record 23.83m hectares, up 1% on last year, and just shy of England’s 24.36m total area, the bank said in its Winter Crop Outlook. That tally is also 11% more than the five-year average, with wheat plantings up 1.4% and canola, an oilseed, up by 20.9%. Plantings of barley, oats and pulses have dropped…..

Too much rain, though, has forced some farmers to delay or even replant crops – including three plantings of canola in some parts of New South Wales, Voznesenski said.

Other challenges include higher costs for diesel and agrochemicals from pesticides to fertilisers. And while prices have been hitting record levels globally, limited export capacity has hindered exports, meaning farmers have missed out on some of the best prices, he said.

However, Tanya Barden, chief executive of the Food & Grocery Council, said local food manufacturers hadn’t seen much benefit. They were struggling from unprecedented steepening prices for all manner of inputs, from wheat to energy and freight and packaging costs.

“Input costs had risen by 50% over the last decade, and so profitability has dropped from $8bn [a year] to $5bn, and capital investment stagnated,” Barden said. “Industry now is not in a position where it’s able to keep absorbing all these massive additional levels of cost increases.”

While grocery food prices rose 5.3% in the year to March, according to ABS data, they rose 4% in the previous three months alone, she said.

With the full impact of Russia’s invasion of Ukraine and Covid-related disruptions in China still to be felt, it was likely food price inflation would quicken in this and coming quarters, she said.

A separate report by ANZ on Tuesday, meanwhile, argued the world faced a “prolonged global food crisis” caused by lost exports from Russia and Ukraine, two of the biggest exporters…..

Susan Kilsby, an agriculture economist with ANZ, said food inflation is going to be an issue that will “plague Australia and most other countries” well into 2023.

“Demand for grains tends to be relatively inelastic, so for global grain prices to ease we really need to see an increase in the supply of grain that is available to be exported globally,” Kilsby said.

While wheat plantings in Australia will be large by historical levels, yields may fall from the highs of recent years.

“La Niña brings more rains in Australia and Asia, while drought in the Americas,” she said, adding the timing of the rainfall can also have a big effect on output.

Rabobank in its report noted Australian farmers have been investing heavily in new storage capacity to cope with increased production and also the limited capacity of grain handlers and exporters to move their crops.

Supply chain snags, however, mean some of the additional spending is not resulting in the equipment arriving.

In some cases, farmers “can order them, but they’re not even told when they can get” the extra storage, with waits stretching out to a year.

“There’s a lot less certainty in their world at the moment,” Rabobank’s Voznesenski said. [my yellow highlighting]

Soybean farmers on NSW North Coast suffer near-total crop losses. Region grows high-end soy bean crop for foods such as tofu with estimated value of $20 million. Ongoing rain after Feburary-March flooding is causing further losses.

That record flood caused extensive damage to the NSW Sugar Milling Co-operative’s three sugar mills on the Northern Rivers and 3,000 tonnes of raw sugar had to be condemned at Harwood, but it is expected that Condong on the Tweed and Harwood on the Clarence will be operational for the late June start to crushing while the Broadwater enterprise on the Richmond, which experienced extensive damage to the steam and power generation facility may not be fully operational until the end of August.

Australian Institute of Petroleum, Weekly Petrol Prices Report: Week Ending 29 May 2022:

Average Petrol retail price this week: 200.0 cents

Average Petrol wholesale price this week: 189.7 cents

Prices have been rising steadily. With the average petrol retail price for the week ending 1 May 2022 coming in at 178.2 cents and the average petrol wholesale price at 163.1 cents.

The week ending 8 May saw the retail price at 179.6 cents and wholesale price 169.2 cents. By the week ending 15 May average prices had risen to retail 185.0 cents and wholesale 178.7 cents. The following week ending 22 May averages prices had again increased to retail 199.1 cents and wholesale 183.3 cents.

Australian Energy Market, AER Statement – Retail Market, 1 June 2022, excerpt:

As outlined in both our Q1 Quarterly Wholesale Report and our Final Determination of the Default Market Offer last week, there continues to be volatility in the wholesale energy market resulting in added cost pressures on both retailers and consumers.

The AER is closely monitoring the situation in both the wholesale and retail markets and ensuring all participants are complying with the law and the rules…..

ABS, Australian National Accounts: National Income, Expenditure and Product, March 2022, 1 June 2022:

The La Nina weather cycle influenced Australia’s weather during summer and early autumn, leading to severe flooding in areas of south-east Queensland and northern New South Wales.

The impacts of these events can be seen in key national accounts aggregates. Severe storms disrupted mining and construction activity, resulting in reduced gross value added for these industries. Residential and commercial properties were damaged, resulting in increased non-life insurance claims and governments increased spending on defence assistance for affected areas.

~~~~~~~~~~~~~~~~~~~~~~~~~

Industry Gross Value Added

The response to the L-strain outbreak of COVID-19 led to a large fall in gross value added (GVA) in the June quarter 2020, driven by a record decrease in market sector GVA. Impacts were widespread throughout market industries, with only Mining and Financial and Insurance Services recording growth. The largest falls were seen in tourism and hospitality-related industries, reflecting the restrictions imposed on movement.

Non-market GVA declined driven by Health Care and Social Assistance. Elective surgeries were cancelled and visits to health care professionals declined as households sought to limit the spread of the virus. Both market and non-market GVA partially recovered in the September quarter 2020 as restrictions were lifted.

The Delta strain of COVID-19 had similar effects on market and non-market GVA, with trading and mobility restrictions reducing demand for many goods and services. The falls were not as pronounced as those that occurred during the L-strain, as fewer states experienced outbreaks. Additionally, trading frameworks such as COVID-19 safety plans were developed to allow some businesses in affected states to keep operating under restrictions such as mandatory QR check-ins for patrons and venue capacity limits.

The absence of lockdowns under the Omicron variant resulted in a lower impact on demand. While restrictions were less stringent, hours worked fell due to high COVID-19 infection rates and subsequent isolation requirements. Market sector GVA rose in the March quarter 2022, with the reopening of domestic and international borders. Growth was recorded in travel-related industries such as Transport, Postal and Warehousing and Accommodation and Food Services. Non-market GVA fell due to a contraction in Health Care and Social Assistance, however the fall was less severe than for the prior strains.

~~~~~~~~~~~~~~~~~~~~~~~~~

UPDATE

ABC News, 3 June 2022:

Australian manufacturers facing massive increases in gas prices are warning they could be forced to shut, with tens of thousands of jobs on the line.

Gas prices on the spot market have quadrupled amid supply constraints, local coal-fired power station outages, and the war in Ukraine.

Australia's largest plastics producer Qenos buys about 40 per cent of its gas on the open market.

"Prices have gone up in the spot market to between $30 and $40 a gigajoule. In fact, that's in a month alone, that's an increase of 300 to 400 per cent," Qenos chief executive Steve Bell said.

"For energy-intensive businesses like ours that is not sustainable."….

On Wednesday, AEMO triggered the Gas Supply Guarantee Mechanism for the first time since it was introduced in 2017. The mechanism calls for the market to release supply and come up with a plan to address a potential shortfall.

Analyst Gilles Walgenwitz said without enough renewables capacity in the grid to make up the shortfall, local coal fired power station outages were also pushing up gas prices.

"We have about six gigawatts of coal capacity missing in Queensland, six gigawatts in New South Wales. That's huge, when you compare to the total capacity normally available," he said.

"And so, we have much more gas power generation coming into play to meet the demand and it happens that at the same time, the price of gas is extremely high."