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It has been a volatile start to the year with the Australian share market coming under pressure due to rising inflationary pressures, talk of higher interest rates and economic uncertainty stemming from the pandemic.

After gaining 13 percent in 2021, the S&P/ASX 200 Index has also faced some geopolitical headwinds from a potential conflict between Russia and Ukraine.

A surprise increase in the inflation figures for the December quarter spooked an already-unsettled market. However, early indications from corporate earnings for the December half have tempered the sell-off with the benchmark index down around 2 percent so far in 2022.

There are some lingering concerns around rising prices and corporate Australia’s ability to pass on higher costs.

Price pressure

The annual headline inflation figure hit 3.5 percent, while underlying inflation was also higher-than-expected coming in at 2.6 percent, resulting in the Reserve Bank of Australia (RBA) raising its forecasts for an underlying inflation rate to 3.25 percent before falling to about 2.75 percent in 2023. 

Despite sitting above the bank’s 2-3 percent inflation target band, the RBA said wages growth –which it believes needs to be running at 3 percent or more for inflation to be sustainable – was subdued.

High inflation diminishes financial returns and may lead to higher operational costs for companies as they need to source materials and labour, while higher interest rates may also impact company profitability. 

Petrol prices, the cost of new dwelling construction materials, motor vehicles and other goods were the key factors driving inflation higher. The price spike has also been attributed to global supply chain disruptions along with higher freight costs and increased demand.

Global markets have been rattled by the US Federal Reserve which has made it clear that it will end its policy of ultra-low interest rates with the first rate rise in the US expected in March with a further three more possible in 2022.

Rates on hold

The RBA kept the official cash rate at 0.1 percent and ended its $350 billion bond-buying program due to a lower jobless rate and higher inflation. It said interest rates in Australia would most likely remain steady until there were signs of wages growth.

“It’s certainly a plausible scenario rates go up later this year, but there are a lot of other scenarios as well. There are a lot of uncertainties both on the supply side and in the labour market,” RBA governor Philip Lowe said.

Dr Lowe said while the pandemic had affected the economy, he was confident unemployment would continue to fall due to high job vacancies.

Unemployment currently sits at 4.2 percent, the lowest it has been since the mining boom in 2008.

The jobless rate is now forecast to fall below 4 percent later in 2022 and to be around 3.75 percent at the end of 2023.