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Surging inflation puts pressure on monetary policy

Trimmed mean inflation rose to 2.1% in Australia in Q3, the first time it has entered the RBA’s 2-3% target band since 2015. Even more strikingly, trimmed mean inflation in New Zealand rose to 4.4%, way above the top end of the RBNZ’s 1-3% target. One driver of the strength in both countries has been the surge in the cost of building a new home, which rose 3.3% q/q in Australia and 4.5% in New Zealand. Construction businesses are still reporting high input costs so home building inflation could push underlying inflation even higher in the quarters ahead. Rising food and energy prices provide additional upward pressure. Indeed, central banks have started to respond. If the labour market remains resilient, the RBNZ could hike rates by 50bp in November. And while stronger wage growth will be necessary before the RBA begins hiking, we think the strength in underlying inflation will encourage the RBA to continue tapering its asset purchases from February.
Ben Udy Australia and New Zealand Economist
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Despite the rise in virus cases in recent weeks, strong inflation in New Zealand increases the pressure on the RBNZ to tighten policy further. While we are sticking to our forecast of a 25bp hike in November, there is certainly a risk that the Bank decides to hike rates by 50bps. Meanwhile, in Australia, the RBA defended its yield target this week as markets continue to challenge the RBA’s view that rates will be on hold until 2024. We’re less hawkish than financial markets but we do think wage growth will pick up faster than the RBA expects. Indeed, we expect the Bank to start hiking rates in early 2023.

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