What is the outlook for inflation in 2023?
High inflation has been the big surprise this year. It has driven an aggressive tightening in monetary policy and a sharp rise in the risk of recession, which has in turn driven a plunge in sharemarkets.
The good news is that it’s likely to surprise on the downside in 2023. The surge in inflation has been driven by a combination of: supply-side disruptions flowing from the pandemic; strong goods demand through the pandemic that depleted inventories and then a surge in services demand on reopening at a time of limited spare capacity and now tight labour markets; higher commodity prices flowing from Russia’s invasion of Ukraine; and very strong money supply growth through the pandemic.
Now there are indications that inflationary pressures are starting to top out or reverse:
• Uncertainty remains high around the war in Ukraine, but gas and coal prices may have seen their worst, and oil, metal and food prices are off their highs.
• Measures of supply disruption are easing, with business surveys showing falling delivery times, and work backlogs and freight rates are down from their highs.
• This is being reflected in a rollover in producer price inflation outside Europe.
• Business surveys also show – outside
Europe – that input and output price inflation is off its high.
• Goods inflation appears to have peaked.
• And slower demand (or GDP growth) will lead to reduced capacity utilisation and eventually higher unemployment, which will see overall inflation, particularly for services, peak.
• At the same time, money supply growth has fallen.
This is being reflected in AMP’s Pipeline Inflation Indicator, which is now pointing to a sharp fall in US inflation.
As a result, we expect inflation to fall faster than the Federal Reserve and Reserve Bank are allowing for next year, with inflation expected to fall to around 3.5% in Australia. This will see some easing in cost-of- living pressures as wages growth by then will likely have picked up to be at least in line with inflation.
It should also allow the RBA to start cutting rates by late next year, albeit only tentatively at first, and the cash rate is unlikely to fall back to anywhere near as low as the 0.1% seen in 2021.