Beware of an unexpected inflation twist: Robert Gottliebsen

The inflation/interest rate conundrum is set to take a new and unexpected turn. Picture: Gaye Gerard / NCA Newswire.

The Australian inflation/interest rate conundrum is set to experience a new and unexpected twist.

Around Australia, significant importers of consumer and other goods are being contacted by their suppliers in China and other parts of Asia warning that prices will rise significantly later in the year.

In countries like China, after years of cost containment, the population is looking for greater rewards. Costs are also boosted by higher energy and steel prices plus Covid issues.

For decades China has kept a lid on US, Australian and world inflation. The message coming from Chinese suppliers is that they are now set to export cost increases, especially to countries like Australia and the US where demand is strong.

As this message is conveyed to senior Australian managers and directors, many companies are vowing that this time, cost increases will be reflected in prices. The current strong demand and the Reserve Bank’s forecast that the robust economy will continue, makes managers and directors confident that the market in many areas will absorb the price rises.

Last year companies absorbed many cost increases, partly because turnover was stronger than expected and there were also substantial cost savings achieved through better productivity -often driven by the adaptation to the Covid pandemic.

In addition, big retailers and other large groups in 2021 often squeezed suppliers to a point where survival now depends on passing cost rises onto customers.

Accordingly, some of the factors that have kept a lid on inflation during 2021 no longer exist.

The other major 2021 inflationary lid was the attitude that many enterprises adopted in setting wage and salary levels. Those people with valuable skills either in the professions or in the so called trades received worthwhile income rises to retain their talents.

But most of those who had limited skills or who were unskilled simply did not receive worthwhile pay increases.

The so called “unskilled” pool is being boosted by local students looking to gain income and improve their CV. Many are keen which augers well for the future.

Nevertheless, we are creating a society where those that do not obtain skills are going to suffer.

The Reserve Bank is waiting for wages to catch up with price increases, but this two-tier wage society may obscure the patterns that have been established in previous decades.

In former times, enterprises like cafes or restaurants would bid up for unskilled talent when there were shortages. These days the restaurants simply shut. Sometimes the absence of workers is created by Covid issues but at other times it is simply the unavailability of people.

A friend of mine was in Noosa recently and found that a large number of his favourite restaurants were shut because of the unavailability of people. He went home early.

It is possible that later in the year a Fair Work Commission may award large increases in minimum wage payments but there is no certainty.

Again in former years, state governments, particularly ALP governments, would spray money to public servants that would ignite widespread wage rises. These days many states have borrowed heavily and are facing higher interest bills so can no longer afford to be wage pacesetters.

The Victorian government, which ignited wage pressures in past years, last week contained teacher annual wage rises to two per cent a year for the next four years, although the government made productivity sacrifices which will boost the total bill.

Obviously when the imported goods price increases hit the shelves, each enterprise will need to determine whether to maintain their current intention of lifting prices or whether to have second thoughts.

At the same time there is danger of further oil price driven cost increases, because the capital markets’ pressure on the large oil companies not to invest is becoming more intense. Exploration was reduced years ago which is now impacting supply at a time when oil demand remains high. Exxon is planning an enormous share buyback rather than boosting production. In addition, if Russia invades Ukraine brace for further big oil price spikes.

Clearly predicting well into the year is very speculative, but there is a real chance that we will experience inflation driven by price increases that are not fully reflected in wage levels.

If that takes place, the Reserve Bank will need to recalibrate its interest rate schedule to slow the economy to prevent and curb the price rises.

Meanwhile, in many areas the shortage of building skills is becoming worse and in some places people are buying land who want to get their home started. But there is no capacity to build until 2024. Like the cafes that are closing, the builders are preferring to delay activity rather than bidding up labour costs even further. Meanwhile those building component and builders who tendered on fixed price contracts face more pain because the cost of imported materials is set to rise in price.

We are entering in an old style environment where being an economist involves much more than analysing figures – you must relate those figures to what is happening in the real world.