Key Takeaways:
- The largest contributor to inflation is rising fuel prices, which are increasing freight costs for businesses that rely on transporting goods.
- Floods and bushfires have temporarily increased fruit, vegetable and meat prices, supporting demand for substitute goods.
- Financial lenders can benefit from high inflation and increase their potential interest earnings, as consumers and businesses require additional capital for the same goods.
Inflation has grown 5.9% in the past year – the largest single-year increase since 2001. Significant supply chain disruptions, coupled with high global and domestic demand, have contributed to considerable price increases in fuel and food. But whose wallets will suffer the most?
Fuelling the growth
The largest product price increase driving inflation is the price of fuel, which increased by an average 35.1% over the year through March 2022. This rapid growth can be partly attributed to global sanctions against exports from Russia, which have been in place since the beginning of the Russia-Ukraine conflict and have severely constrained the available fuel supply. Demand for fuel has also surged as COVID-19 restrictions continue to ease globally, which has further boosted fuel prices. According to Senior Industry Analyst Victoria Baikie, ‘consumers and businesses have had to fork out much more at the pump for the same quantity of fuel, which has been a leading contributor to a spike in inflation.’
Freight costs: cause for a fright?
Fuel is a key input for transport businesses. Consumers and businesses in regional Australia are much more reliant on road freight transport than those located in urban city centres. Farmers also rely on truck drivers to transport agricultural produce to consumers and bring in important inputs, such as fertiliser. An increase in the cost of fuel has increased the cost of transporting goods, placing upwards pressure on input prices for farmers. Where substitute farming input products that avoid high increases in transport costs are available, prices are unlikely to increase. However, the quality or quantity of produce may suffer if farmers have to use a lesser quality substitute. Moreover, farmers are less likely to fully pass on cost increases due to the supermarket giants’ significant bargaining power, which can reduce farmgate prices.
Severe floods across the country, particularly in much of New South Wales and Queensland, have wiped out significant quantities of farm produce and damaged transport infrastructure, including Australia’s main east-west rail corridor. This damage has worsened food shortages in the Northern Territory and Western Australia. Businesses have also had to account for the added cost of detours and a heightened reliance on road transport when purchasing freight, with high fuel prices further compounding the issue. As a result, vegetable prices have increased by 12.7% and beef and veal prices have increased by 12.1% on average over the year through March 2022. ‘Rising transport costs have converged with constrained domestic food supply, and the resulting price increases are unavoidable for consumers,’ explained Ms Baikie.
Environmental impacts on supply
Australia is no stranger to short-term spikes in food prices due to environmental disasters. The Black Summer bushfires in 2019-20 damaged over 2.6 million hectares of agricultural land. The damage sustained from these bushfires is estimated to cost farmers up to $5.0 million. As a result, the price of vegetables, including cauliflower, broccoli, rocket, potatoes and pumpkins, increased. Going back as far as 2011, the price of bananas soared to $12.00 per kilogram following Cyclone Yasi in Queensland, and took approximately six months to return to normal. According to the Australian Institute for Disaster Resilience, climate change will likely cause natural disasters to occur more often and at an increasing severity. Food shortages are also projected to become more frequent, contributing to higher prices for some fruits or vegetables over longer time periods. These factors will likely add up to higher inflation in the future. A shorter recovery period between disasters may also constrain farmers’ revenue streams and encourage them to use cheaper, lower quality substitute inputs, which could affect the quality of their produce.
The flow-on effects of price hikes
Rising food and transportation costs are expected to dampen profitability for food-service establishments and accommodation providers. These conditions could also open the door to substitute food products infiltrating the market as businesses forego an uncertain and expensive domestic supply of commonly used meats and vegetables. Alternative ingredients could include lower cost imported products, which may end up being more affordable despite requiring additional transportation. ‘Ingredients and other inputs can account for 30% to 40% of revenue for food-service establishments. Given that profit averages less than 5% across the sector, any increase in food costs will cut into a business’s already paper-thin margins,’ said Ms Baikie.
Increasing food and fuel costs are also likely to negatively affect the wider tourism sector. Additional transport costs and further cost-of-living constraints may dissuade consumers from undertaking discretionary travel – a worrying possibility as the tourism sector recovers from multiple years of low demand during the COVID-19 pandemic. Additional price increases at food-service establishments will likely further reduce demand for travel, weakening demand for accommodation providers.
Retailers that rely on transporting goods over long distances are also vulnerable to high inflation. Motor vehicle prices have increased by 6.6% over the year through March 2022. Motor vehicle dealers have battled ongoing supply chain disruptions associated with the Russia-Ukraine conflict and lockdowns in parts of China. Imports account for 88.0% of domestic demand for motor vehicles, meaning the automotive sector is significantly exposed to global supply disruptions. Nonetheless, global and domestic demand for motor vehicles remains high, contributing to higher prices. This trend may create a greater reliance on procurement professionals within the manufacturing, wholesaling and retail sectors to source motor vehicles and parts from locations that have been the least affected by disruptions.
Who wins?
If there are any winners from high inflation, they seem to be few and far between. Rising fuel and food costs affect every consumer and business to some degree. However, some are expected to fare better than others.
Housing prices have soared over the year through March 2022, increasing by an average 13.7%. Homeowners can now receive greater returns for their homes than they could a year ago. This trend may incentivise some consumers to sell their properties, increasing demand for real estate services. However, housing prices are widely anticipated to fall over the next year, mainly in Sydney and Melbourne, offsetting some of the increase in desire to sell. Additionally, supply disruptions for steel and wood have led to rising costs and expected delays in residential construction, which may deter consumers from undertaking new housing or renovation projects.
Financial lenders are also likely to benefit from high inflation. To purchase property, equipment or other assets, consumers and businesses alike are expected to pay more now for the same product than they would have a year ago. They will therefore need to take out a larger loan to afford the asset. Financial lenders, including banks, can earn more interest from larger amounts of financing, supporting revenue growth. The recent 0.25 percentage point increase in the cash rate has further supported this trend, as banks and other financial lenders have initiated rate hikes following the announcement. The cash rate is projected to continue rising over the course of the next five years, further increasing potential interest earnings for financial institutions.
Outlook
Inflation is forecast to eventually – and perhaps thankfully – come down from this high. Supply chain disruptions across multiple products, especially fuel, will likely be resolved in the short-to-medium term, easing some pricing pressures. This will be a particularly welcome development for sectors that rely on long-distance transport, including imports. In the meantime, asset owners and lenders are anticipated to benefit from high inflation, while financial lenders will benefit over the medium-to-long term due to higher interest rates on higher loans. Higher interest rates may also benefit homeowners over the short term, if they are required to purchase another property after selling.
Alfabank-Adres reports used in this article:
