The spike in inflation isn’t coming from input cost pressures, despite the rate rises; it comes from businesses broadening their profit margins while claiming higher energy costs and wage rises. Rising profits are the primary driver of inflation, not the cost of inputs or excessive demand. Many corporates say ‘they’ve got no choice‘ but to lift prices when costs rise.
How are bloated profits leading to inflation?
Yet they are lifting prices well above these cost increases. Modelling from the Australia Institute suggests that the current squeeze is an avoidable one. “Bloated business profits account for 60% of current inflation; unit labour costs accounted for only 15%. A change to government policy rather than an oversimplified approach of raising the cash rate will be needed to address the current bout of inflation,” says Ulrika Lobo, director of Sparrow Loans.
“High demand is leading the RBA to run ahead with its rate increases because people’s spending habits are not reacting to higher rates in conventional ways. This is probably because they are not feeling the full effects of inflation yet while enjoying some short-term relief from increased wages. Businesses are increasing prices above the change in the cost of inputs, exacerbating the upcoming cost of living crunch,” Ms Lobo further commented.
They are acting on the belief that as rates rise, consumption falls as people stop spending on unnecessary purchases. An increasing profit margin is not what the RBA wants; they want ‘an increasing price level’ related to a market correction and inflation to curb consumer spending before they stop the rate rises. Yet consumption remains strong as retail sales hit an all-time high of $34.7bn in July, up 1.3% from the month before and up 16.5% from last year.
What does the rise in rates mean for property values?
“While much of the current inflation is avoidable and attributed to profit-motivated businesses, high consumption is causing the Reserve Bank of Australia (RBA) to steam ahead with tighter monetary policy leading us into an inflationary spiral,” says Ulrika Lobo.
“Borrowers receive a 32-day notice period before having to pay a higher minimum payment. There is a lag of about two to three months for the larger lenders once they adjust policy and give notice to borrowers. The cumulative effect of all the recent rate rises is yet to be seen.”
“This explains CBA’s anticipated drop in property values, a warning against aggressive rate rises, affects all property-backed lenders. Competition policies would have a big effect on limiting the rate of inflation given that profits account for the 60% of cost increases,” she said. Sparrow Loans monitors cost challenges to prepare serviceability hiccups. Lenders’ response to increasing costs determines market liquidity, which buoys the property market.