May economic update

The shift to a higher-interest rate environment, amid growing inflationary pressures and the withdrawal of COVID-induced stimulus measures, has been the main focus of global markets in recent weeks. Market unease was further exacerbated by renewed pandemic-related lockdowns in China and the war in Ukraine which have intensified supply chain disruptions.

The Reserve Bank of Australia raised interest rates for the first time in more than 11 years when the cash rate went from a record low 0.1 percent to 0.35 percent, with the RBA signalling more increases are likely.  

"The board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.  This will require a further lift in interest rates over the period ahead,” RBA Governor Philip Lowe said.

Higher interest rates result in increased borrowing costs, lower valuations for growth stocks such as tech companies, and rising bond yields which can attract investors away from the stock market.

In the U.S., where inflation has hit 40-year highs, the Federal Reserve increased interest rates by 0.5 percent in the biggest increase since 2000, adding that further rate rises are on the horizon this year.

Inflation spikes

Domestically, headline inflation rose to 5.1 percent in the first three months of the year, the highest annual level in more than 20 years. The underlying inflation -- the Reserve Bank’s preferred measure strips out large price movements such as for petrol -- rose by 3.7 percent which is outside the RBA’s target band of 2 to 3 percent.

Market economists have been saying that inflation is spreading beyond rising commodity prices and that the RBA needed to start lifting interest rates to help keep inflation in check.

Australian households faced the bulk of the price rises with expenses such as food, petrol, housing and health costs jumping 6.6 percent in the year to March. There were also increases for all food and non-food grocery products which the Australian Bureau of Statistics said was due to a range of price pressures including transport costs, supply chain disruptions and increased input costs.

The spike in inflation has been spurred by a tight labour market, record low interest rates and a hefty dose of government spending. In turn, that has driven household demand for goods and services which have become more expensive. The higher prices, along with increased transport costs, are passed on to consumers and that feeds into the prices consumers pay.

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.