Second, he believes that by raising the front-loading rate, the RBA has been dealing with wage growth in Australia. As inflationary pressure eases over the next 12 months, upward pressure on wages should also ease, giving the RBA less work to do.
“I don’t think it’s as urgent here as in the US, where wage growth has been much stronger,” he says.
The caveat to Redican’s view is that uncertainty remains high; a further burst of rising energy prices due to the war in Ukraine, for example, could easily reverse the likely pullback in inflation.
Indeed, his base case is that once this current bout of inflation ends, the global economy and financial markets will remain vulnerable to sharp inflationary cycles that will be more frequent than those of the past two decades.
“A Risky Thing”
Redican says investors should be skeptical of the market’s forecast of interest rates reaching 3 percent and then falling as inflation fades.
“If you look at break-even inflation rates in Australia or the United States, they’re saying that after this episode is gone, we won’t have to worry about inflation anymore. And I think that’s a really risky thing.”
The factors that have pushed inflation up in this current episode underpin Redican’s long-term view. Not only are the cheap and flexible global supply chains of the last decade likely gone, but the challenge posed by the energy transition means that sudden spikes in energy prices are common.
Demand for fossil fuels will continue to decline in the long term as renewables provide an increasing proportion of the world’s energy needs. But the bumpy nature of this transition means there will be times when increasingly scarce fossil fuels are needed, driving up energy prices and subsequently inflation.
“Once we make that transition, I think things will go back to normal. But during the transition period, we’re really exposed on a number of fronts,” says Redican.
Central banks will not want to risk inflation driving up wages and will therefore need to react to these supply shocks. As a result, Redican says inflation could average 3 percent over five years instead of 2 percent, with bond yields averaging 4 percent instead of 3 percent.
That could require some adjustments from investors accustomed to supporting central banks, companies that have relied on cost-cutting and borrowing to fuel profit growth, and households that have turned to property.