The Experts

Inflation trends higher

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Consumer price index

  • Inflation: The Consumer Price Index – the main measure of inflation in Australia – rose by 0.5 per cent in the December quarter, below expectations for a lift of 0.7 per cent. In seasonally adjusted terms the CPI rose by 0.5 per cent. The annual rate of inflation rose from 1.3 per cent to 1.5 per cent.
  • Underlying measures: The Reserve Bank monitors three measures to derive the underlying inflation rate. The trimmed mean rose by 0.4 per cent in the December quarter (1.6 per cent annual); the weighted median rose by 0.4 per cent (1.5 per cent annual) and the CPI less volatile items rose by 0.3 per cent (1.3 per cent annual). Overall, underlying inflation rose by 0.4 per cent in the quarter and by 1.5 per cent over the year.
  • Main changes: Tobacco prices rose by 7.4 per cent, with petrol up 6.7 per cent, domestic travel and accommodation up 5.5 per cent and home purchase up 0.5 per cent. The CPI was dragged lower by a 2.6 per cent fall in international holiday travel and accommodation, 5.1 per cent fall in clothing “accessories” and 3.2 per cent fall in waters, soft drink and juices.
  • Notable changes: Women’s clothing is the cheapest on record (27 years); car prices are the lowest levels since 1987 (29 years); milk is the cheapest in 11 years; telecom equipment is the cheapest in 17 years.

What does it all mean?

Inflation has bottomed, but it certainly doesn’t seem on a sharp acceleration path. Annual inflation has lifted from 1.0 per cent to 1.5 per cent over the past six months, but it remains well below the Reserve Bank’s 2-3 per cent target band.

But while inflation is not yet a concern for the Reserve Bank, interestingly consumers have other ideas. The latest weekly consumer sentiment survey by Roy Morgan and ANZ put inflationary expectations (forecasts out two years) at the highest level in 4½ years. No doubt the lift in petrol prices has spooked consumers and caused them to take their eyes off other prices which are either falling or becalmed.

It is clear that interest rates will stay low for an extended period. The Reserve Bank doesn’t need to cut rates again with inflation trending higher, rather than lower. And there are doubts that rate cuts would actually do much in terms of driving the economy higher and lifting inflation. And rate hikes are off the agenda. Crucially, global competition ensures that retailers can’t lift prices in the current environment.

Indeed global competition is still a significant factor in restraining price pressures. Simply, consumers can buy goods whenever they want and wherever they are. Retailers have to watch their local as well as their global competitors.

While inflation is still low, there is no room for complacency. “Non-tradable” goods prices rose by 0.8 per cent in the December quarter. These prices are more influenced by conditions in Australia, rather than global factors. And as noted, consumer inflationary expectations have lifted.

What do the figures show?

  • The All Groups Consumer Price Index (CPI) rose by 0.5 per cent in the December quarter, below expectations for a lift of 0.7 per cent. In seasonally adjusted terms the CPI rose by 0.5 per cent. The annual rate of inflation rose from 1.3 per cent to 1.5 per cent.
  • Underlying measures of inflation were slightly below forecasts in the December quarter. The trimmed mean rose by 0.4 per cent in the December quarter (1.6 per cent annual); the weighted median rose by 0.4 per cent (1.5 per cent annual) and the CPI less volatile items rose by 0.3 per cent (1.3 per cent annual). Overall, underlying inflation rose by 0.4 per cent in the quarter and by 1.5 per cent over the year.
  • The ABS noted: “The most significant price rises this quarter are tobacco (+7.4 per cent), automotive fuel (+6.7 per cent), domestic holiday travel and accommodation (+5.5 per cent) and new dwelling purchase by owner-occupiers (+0.5 per cent). The most significant offsetting price falls this quarter are international holiday travel and accommodation (-2.6 per cent), clothing accessories (-5.1 per cent) and waters, soft drinks and juices (-3.2 per cent).”
  • Prices of tradables fell by 0.1 per cent in the December quarter. “The most significant contributor to the 0.2 per cent rise in the tradable goods component is automotive fuel (+6.7 per cent). The most significant offsetting fall in the tradable goods component is accessories (-5.1 per cent). The fall in the tradable services component of 2.5 per cent is driven by international holiday travel and accommodation (-2.6 per cent).”
  • Prices of non-tradables rose by 0.8 per cent in the December quarter. “The most significant contributor to the 1.1 per cent rise in the non-tradable goods component is tobacco (+7.4 per cent). The most significant offsetting fall in the non-tradable goods component is pharmaceutical products (-2.6 per cent). The rise in the non-tradable services component of 0.6 per cent is driven by domestic holiday travel and accommodation (+5.5 per cent). The most significant offsetting fall in the non-tradable services component is telecommunication equipment and services (-0.8 per cent).”
  • Tradable goods are those items whose prices are largely determined on the world market. Non-tradable prices are more affected by domestic economic conditions.
  • Over the last 12 months, the tradables component rose by 0.1 per cent, while the non-tradables component rose 2.1 per cent.
  • Capital cities: Sydney +0.5 per cent in the quarter (annual +1.8 per cent); Melbourne +0.7 per cent (+1.5 per cent); Brisbane +0.5 per cent (+1.6 per cent); Adelaide +0.3 per cent (+1.3 per cent); Perth +0.4 per cent (+0.4 per cent); Hobart +0.8 per cent (+1.3 per cent); Darwin -0.1 per cent (-0.4 per cent); Canberra +0.6 per cent (+1.8 per cent).

Why is the data important?

The Consumer Price Index (CPI) is regarded as Australia’s premier measure of inflation. The CPI is published quarterly and measures price changes for a ‘basket’ of goods and services that dominate expenditure of metropolitan households. The “All Groups” index is the main focus, but other inflation measures are also published such as so-called ‘underlying’ measures. These include measures that abstract from price changes in volatile price items such as fresh food and petrol.

The Reserve Bank aims to keep the headline inflation rate between 2-3 per cent over an economic cycle. If inflation is high and expected to rise, the Reserve Bank may elect to raise interest rates in order to constrain price pressures. Conversely, if inflation is low and expected to remain low, the Reserve Bank may elect to cut interest rates if it believes the growth pace of the economy is in need of strengthening.

What are the implications?

Before Wednesday’s data, financial markets were pricing in an 8 per cent chance of a rate cut over 2017. Now a rate cut is seen as a 14 per cent chance. While the latest inflation result was below market forecasts, it’s important to note that it was bang in line with the Reserve Bank’s forecasts. The Reserve Bank had expected 1.5 per cent annual inflation in the December quarter for both headline and underlying measures. Inflation is seen at 1.5-2.5 per cent over 2017.

It is important to watch inflation expectations each week to track how consumers (and potentially business price-setters) are viewing the landscape.

Published: Friday, January 27, 2017

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