If the Reserve Bank lifts interest rates on Tuesday, governor Michele Bullock may well cite the need to keep consumers’ expectations of inflation “anchored”.
But it’s not a simple task to determine what those expectations are and whether they are anchored to reality.
Of 39 economists surveyed by Reuters, 34 forecast the RBA will raise its cash rate another 25 basis-points to 4.35%, the 13th increase since May 2022.
Bullock used her first speech since becoming governor in September to stress “the important role of inflation expectations” in determining how high interest rates would go and for how long in order to drag inflation back to the bank’s 2%-3% goal.
“The longer a central bank permits inflation to remain outside that target, the more likely it is that inflation expectations will shift,” she said. “And if they do, it will require even higher interest rates and unemployment to bring inflation back to target.”
Those expectations remain “well anchored but the longer you remain out of that band the more likely it is you’ll become unanchored”, Bullock said, a day before September-quarter data revealed inflation was running higher than predicted.
However, calculating what those expectations are – and when the anchor might be slipping – isn’t straightforward. Some critics, such as Jeremy Rudd, an adviser to the US Federal Reserve, argue the belief actual inflation is set by households’ and firms’ view of future inflation “rests on extremely shaky foundations”.
The RBA economists Yahdullah Haidari and Gulnara Nolan argued in a paper published last year that high inflation expectations “can have significant consequences for the economy … and can become self-reinforcing”.
“A key risk that could arise from a period of elevated inflation is that firms and households come to expect continued high levels of inflation into the future – and that this shifts behaviour in ways that are hard to reverse,” they said.
Interestingly, they found consumers “persistently” expect inflation to be higher than actual price increases, based on data compiled by the Melbourne Institute every month since 1995.
Women typically expect inflation to be higher than men do. Respondents with a university education, higher income and in professional jobs had lower inflation expectations. Those living in regional areas and renting instead of owning their home typically had higher ones. Age did not appear to make a difference.
Sam Tsiaplias, a principal research fellow at the Melbourne Institute, has processed the expectation surveys of 1,200 respondents for the past decade. He said consumers’ inflation expectations had lately been falling with high interest rates: “That’s consistent with the notion that inflation expectations are not unanchored.”
Tsiaplias said consumers were mostly influenced by prices that they see on an everyday basis. These included fuel prices – often brightly advertised – and the groceries they buy in supermarkets. “Extreme” prices, too, can sway impressions.
The notion of anchoring itself, though, remains “hard to measure”, he said.
One sign of de-anchoring would be if households and firms became unresponsive to RBA decisions, believing that high inflation was here to stay. “Fortunately, we haven’t seen anything like that.”
Nor are there signs of a feared “price-wage spiral”, Tsiaplias said.
Timo Henckel, a research fellow in the Centre for Applied Macroeconomic Analysis at the Australian National University, expects the RBA to raise rates again on Tuesday, as does the centre’s shadow RBA board.
Even if the “first round” of inflation was sourced from a Covid-related supply shock or a spike in energy prices, the RBA would be considering the second and later rounds of pricing pressures in the economy, he said.
“When you’ve got high inflation expectations, which then lead to high wage increases,” Henckel said. “Then you’ve got that self-fulfilling prophecy – a vicious cycle that takes place – and that’s much, much harder to break.”
Jonathan Kearns, who headed several key RBA departments before leaving in February to become chief economist at Challenger, also predicts the central bank will lift rates again on Tuesday.
He said the recent quarter of inflation was “predominantly larger” than the RBA had previously pencilled in because of higher fuel prices. And at 5.4%, Australia’s annual inflation rate remains far from the 2%-3% goal, giving the central bank less wriggle-room.
“You can’t ignore those sorts of supply and oil shocks as much as you ordinarily would if you were close to [the inflation] target,” Kearns said.
