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The one thing needed to cut inflation

The one thing needed to cut inflation

A number of people have asked me if I think inflation can be contained, and if interest rates can be kept at levels that don’t imperil the economy and impact millions of mortgagees. To my mind, it comes down to one vital step the federal government will need to take.

Anyone who is renovating or building now, or trying to buy a bicycle, steel or timber, a caravan or a new or second-hand car, will know prices have levitated to stratospheric levels, if the item is available at all.

Apparently supply chain bottlenecks, combined with high demand, are to blame for these high prices.

There may be some truth to that, but if supply chain bottlenecks were the only reason, building-supplies companies and other retailers wouldn’t be reporting the record profit margins we’ve seen. When margins today are better than pre-pandemic levels, it suggests that while suppliers might be telling their customers there are supply chain issues, the reality is they are taking advantage of the confusion and lack of transparency to raise prices beyond what can be explained by the pandemic. In other words, some are extorting, gouging and overcharging.

And if that is true, the pressure on prices won’t persist.

But what is the transmission mechanism?

Before answering that question, you will also have noticed the labour market is extraordinarily tight. The Australian Bureau of Statistics reported Australia’s unemployment rate in December at just 4.2 per cent, the lowest level of unemployment in 13 years.

The tight labour market has many investors fearing a wage-price spiral pushing up prices and wages to the extent central banks will need to raise rates aggressively, triggering a recession and a stock market crash.

Of course, stock markets have a habit of jumping at shadows and predicting 10 of the last two recessions!

I offer no predictive ability when it comes to macroeconomics. I leave that forecasting to the economists. I do however see investors’ concerns regarding inflation, wage-price spirals and rapidly rising interest rates, evaporating very quickly if just one occurrence transpires.

And that event, that mechanism, is a re-opening of Australia’s international border.

If borders re-open, a great number of things change very quickly.

First, immigration returns, taking the heat out of the labour market and putting downward pressure on wages. Restaurant owners will no longer be paying $50/hour for washing dishes and retailers will find it much easier to find staff at reasonable rates.

Secondly, opening borders also dramatically changes the demand dynamic in the building game. People who might otherwise have purchased a weekender and subsequently renovated it or rebuilt, will travel overseas for leisure again instead.  Those who might have renovated their own residences, expecting to be forced to work from home for years, will reset their compass. Consequently, demand for building trades and materials, caravans and camper trailers, 4WDs – and everything else people occupy themselves with when they are locked down within Australia’s borders – eases, if not vaporizes.

That’s the transmission mechanism. If borders reopen, demand for building materials and other goods eases, reducing price pressures, and simultaneously, wage pressures. If borders reopen, the fear currently gripping markets turns to euphoria.

All we need to see now is sufficient comfort the worst of the pandemic is over, to reopen borders.

You can also read why Heaven and Earth will always be moved to limit or avoid a significant drop in house prices here: Why I’m still bullish on residential property prices

INVEST WITH MONTGOMERY

Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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2 Comments

  1. I agree raising immigration would put downward pressure on wages and therefore inflation. As such for those of us who have some assets would benefit from the resulting lower interest rate and therefore discount rates our assets are priced off.

    Especially if those assets are funded by debt.

    Not so much for the poorest people in our community who have no assets (including not owning a home) and whose wages would have downward pressure due to the higher immigration.

    For such people, higher inflation which then causes the price of assets such as houses to fall along with raising their wages would benefit from lower immigration.

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