On the face of it, there’s nothing in higher-than-expected inflation data that should halt the rally that has helped the ASX 200 leap 7.5 per cent since the start of the year and put the benchmark index within touching distance of a record high.
Yes, the CPI numbers shocked economists; the headline reading of 7.8 per cent was the highest since 1990 and the trimmed mean measure, which leapt to 6.9 per cent, came in well above the Reserve Bank’s forecast. And yes, the data has all but cemented a 0.25 per cent rate rise when the RBA meets in a couple of weeks.
But bulls will see nothing in Wednesday’s figures to upset the consensus that we are now past the peak of inflation in Australia. Most investors (and the local bond market) already expected the RBA would need to lift rates again in early 2023 before pausing in March or April and then cutting rates in the back half of the year.
On this reading, the New Year rally, which has boosted both big names (BHP is up 8.6 per cent year to date and Commonwealth Bank is up 7.7 per cent) and unloved minnows (Myer is up 41 per cent this year, Nuix is up 35 per cent and Sezzle is up 59 per cent) can theoretically keep running.
But this week’s surprise CPI reading should also serve as a reminder that the inflation story – and the interest rates story that runs parallel – is not over, and the outlook for the consumer is less clear cut than this latest bout of bullishness suggests.
In addition to the latest inflation data, this week has brought a series of analyst notes examining price rises by ASX companies.
On Monday, Macquarie analysts looked at how Domino’s Pizza Enterprises was lifting menu prices by up to 40 per cent in some regions (taking the price of a pizza from its value range to $6.99) as it looked to offset cost increases and shore up the profitability of its franchisees.
On Tuesday, Goldman Sachs initiated coverage on Australia’s general insurance sectors, basing its constructive view on the fact premium increases should underpin an improvement in profit margins.
On Wednesday, Morgan Stanley was one of many banks to comment on Vodafone’s decision to raise prices on its mobile telephone plans by 13 per cent to 18 per cent, following on from similar moves by Telstra and Optus late last year. Macquarie sees the telecommunications sector as being 12 months into a pricing cycle that likely has some years to run.
There is a danger, of course, in extrapolating the experience of any one company, or even one sector to the broader economy. But if nothing else, the above examples suggest that the corporate sector continues to feel the sting of higher input costs and more expensive capital, and consumers will need to pay more if the profit margins are to be maintained. Perhaps this is the tail end of such inflationary pressures, but that’s certainly not clear in sectors such as insurance and telecommunications, which are nondiscretionary items in most households.
But the biggest issue for consumers is the impact of higher interest rates. Although investors in Australia (and in the US) are growing increasingly convinced that the central banks are close to the end of their tightening cycles, it’s remarkable how all the talk of the lag effects of rate rises that so dominated markets just months ago appears to have largely disappeared.
But Jo Masters, chief economist at investment bank Barrenjoey, makes a strong case that for households, the raising cycle remains closer to the start of it than the finish.
The well-documented “mortgage cliff” that confronts thousands of borrowers who will roll off cheap fixed rate loans (averaging about 2.5 per cent) and on to much more expensive variable rates loans (likely somewhere about 6 per cent) has been well documented and much debated.
On Masters’ numbers, this would result in repayments on a 30-year, $500,000 mortgage rising by just over 50 per cent, or $1022 a month.
But she argues it’s also important to recognise that variable borrowers have so far been spared much of the pain of rising rates, largely due to mortgage processing delays.
Barrenjoey estimates average variable mortgage interest rates have only increased about 1.1 per cent so far, compared with the 3 per cent increase in the official cash rates. In other words, just under two thirds of the pain of higher mortgage rates is still to come for variable rate borrowers.
There is clearly some serious catch-up to come. And this will be exacerbated by rate rises in response to still-strong inflation numbers; Masters is holding to her forecast that the RBA will lift by 0.25 percentage points in both March and February, taking the cash rate to 3.5 per cent.
But while official rates might only have 0.5 per cent to rise, Masters estimates the average mortgage rate will rise 1.5 per cent between now and June, and then a further 0.4 per cent in the second half of the year.
For a 30-year, $500,000 variable loan, repayments have risen $300 a month since the RBA started tightening last May. But those repayments are forecast to rise a further $565 over the course of calendar 2023, which Masters estimates is equivalent to a 6.4 per cent squeeze on disposable income.
This helps to explain the robust retail sales figures we’ve seen, both in official data and results from the likes of JB Hi-Fi.
That resilience has also been underpinned by the $260 billion of savings that was built up during the pandemic. But Masters says the savings rate has fallen from 11.2 per cent of disposable income in the March quarter of 2022 to 6.9 per cent in the September quarter.
Barrenjoey expects this rate will fall to 4.4 per cent in the June quarter of 2023 before stabilising.
“This means households have $4 billion to lean on over the first half of this year – much less than the $7.8 billion in the second half of calendar 2022 and $14.3 billion in the first half – but then will need to rely on income growth to support any rise in consumption, particularly given our expectation that house prices will still be falling.”
Income growth and population growth should offset this a bit, but Masters’ forecast is for consumption growth to slow to just 1 per cent through 2023, compared with a forecast 5.7 per cent in 2022.
To be clear, none of Masters’ analysis runs counter to the idea that inflation and interest rates have peaked or are close to it, so the New Year bulls may not necessarily be wrong.
But investors would do well to realise that the pressures on consumers will take a while to fade yet. Prices in some sectors will keep rising and the big jump in mortgage rates is yet to hit.
