Why the RBA will wait before raising interest rates, even as breakfast surges in price

Bread and butter inflation interest rates

Breakfast is supposedly the most important meal of the day. But skipping it could soon be the best financial decision you make. Breakfast foods have been caught up in the great inflationary impulse, with coffee, milk and oats for your muesli all rising sharply in price over the past year.

Inflation in global markets hasn’t yet flowed through to local prices entirely but in time it will. However, a doubling of global oat prices needn’t mean a doubling in the price of your box of toasted Carmen’s muesli. That price is also determined by local logistics, packaging costs, the retailer’s profit margin and competitive concerns. The flow-through of price rises — in markets other than petrol — can be slow. Still, starting the day with lunch might soon be the financially prudent choice.

As coffee goes up, tea might be a better choice. I can inform you that tea prices in global markets are down since 2020, and prices for cocoa are stable. A few squares of chocolate might be just what we need to soothe us as inflation takes hold.

The terror of inflation

The word inflation refers to a rise in prices. Rising prices are persistent over time. It’s why we remember a can of drink costing 50 cents and a house costing $50,000. It’s also why future generations will pay $10 for a can of drink and $10 million for a house.

Experts believe a little bit of inflation is helpful, mostly because it provides a buffer against deflation (falling prices). Falling prices are believed to make people hoard cash and avoid spending, because their money will buy more later. That hoarding of cash stops the economy from continuing on its merry dance, and puts people out of work (in theory). This is why the Reserve Bank of Australia (RBA) aims to keep inflation between 2-3% on average.

Overall, the RBA used to be very bad at this task and has in recent times got a lot better, as the next chart shows.

Still, they miss. Between 2014 and 2021, inflation was mostly below its target and recently it has shot above the target. This has caused much shouting. Many people believe the RBA should raise interest rates now to clamp down on inflation. (Higher interest rates are meant to reduce inflation; lower interest rates are believed to spark inflation — interest rates are the RBA’s main tool for achieving its target of 2-3% inflation.)

Who wins and who loses?

Inflation creates winners and losers. If you hold cash, its buying power falls with inflation and you lose. If you have debt, its size relative to everything else falls with inflation, and you win. Inflation is one reason why the terrifyingly large mortgage you got at age 28 seems manageable at age 40.

Right now inflation is above the 2-3% band. Why hasn’t the RBA hiked rates? To understand why the RBA is cautious, we need to go back to the graph that we started with. The inflation we are seeing now is not caused by domestic optimism. It is caused by fluctuations in global markets.

One way we get inflation is when Australians are rich and bold and happy and buy so much that local retailers start putting up prices. In that case, rising interest rates cool everybody’s ardour and inflation is moderated (people spend more on their mortgage, less at the shops).

But the cause of our current inflation is not powerful local spending (or not solely, anyway). It’s due to disrupted supply chains and the megalomania of one KGB veteran with a nuclear button. If the RBA hikes interest rates now, it won’t change imported prices, and instead will make everyone’s household budget much harder to manage. Nobody wants higher mortgage repayments when they’re already skipping breakfast.

So the RBA waits. It wants to see higher wages growth before it hikes interest rates. And that means inflation will be high for a while yet.

The people who are worse off as we wait will be those on fixed incomes. If your pension paid out $1000 a month and the buying power of $1000 is tumbling, you are getting poorer in real (inflation-adjusted) terms. The government raises payments every six months to try to compensate for inflation — this week, payments to pensioners and recipients of JobSeeker are rising by 2%. People receiving JobSeeker payments will get an extra $13.20 a fortnight.

It’s not nothing, but it’s hardly enough to keep up with the price of food. And remember, JobSeeker recipients were probably already skipping breakfast before the latest surge in prices.

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