Australian inflationary pressures remain subdued

Scott Barbour/Getty ImagesCore inflation has undershot the RBA’s target for several years.
  • Australian inflation rose by 0.5% in the December quarter, leaving the increase over the year at 1.8%. Both figures were marginally ahead of expectations.
  • Underlying inflation rose by a slower 0.4% for the quarter and 1.75% over the year. The year-ended figure was in line with forecasts offered by the RBA in November.
  • Underlying inflation has now undershot the RBA’s 2-3% target for three consecutive years. There’s little evidence to suggest it will return to target anytime soon given recent evidence.
  • The RBA expects it will gradually return to target in the coming years, lifting to the bottom of its range by the middle of this year.
  • Not everyone is convinced that it will, keeping the prospect of a rate cut firmly on the table.

Australian inflationary pressures remained subdued in the final three months of 2018.

According to the Australian Bureau of Statistics (ABS), headline consumer price inflation (CPI) rose by 0.5% during the December quarter, leaving the increase on a year earlier at 1.8%.

Both the quarterly and annual rates were higher than the 0.4% and 1.7% rates expected by financial markets.

However, despite coming slightly above expectations, the annual rate was still the lowest since the final quarter of 2016, and below the 2% level forecast by the RBA in November.

“Annual growth in the CPI remained below 2% in the December quarter 2018,” said Bruce Hockman, Chief Economist at the ABS. “Over the past four years, annual growth in the CPI has only risen above 2% in two of the past 16 quarters.”

The ABS said large increases in items such as tobacco and domestic holiday expenses were partially offset by declines in petrol prices during the quarter.

“The most significant rises in the December quarter were tobacco (9.4%), domestic holiday travel and accommodation (6.2%), fruit (5%), new dwellings purchased by owner-occupiers (0.4%) and furniture (1.8%),” the ABS said.

“Those increases were partially offset by falls in automotive fuel (-2.5%), audio visual and computing equipment (-3.3%), wine (-1.9%) and telecommunications equipment and services (-1.5%).”

ABS

Over the past year, tradable prices rose by 0.6%, some four-times slower than the 2.4% increase in non-tradable items over the same period.

For the quarter, tradable and non-tradable prices were mixed — the former fell by 0.3% while the latter rose by 0.9%.

Tradable prices are largely influenced by offshore factors while non-tradables are impacted by domestic considerations. Non-tradable prices make up around 60% of the ABS CPI basket.

ABS

By location, the scale of price increases over the past year ranged widely. In Darwin and Perth, CPI increased by just 1.2% and 1.3% respectively, significantly less than the 3% and 2.5% increases seen in Hobart and Canberra over the same period.

In Sydney, Melbourne and Brisbane — Australia’s largest cities — CPI increased by 1.7%, 2% and 1.5% respectively from a year earlier.

The variances across the country during this period partially reflect divergent economic conditions with non-mining states clearly seeing stronger inflationary pressures than the mining states.

Hinting that inflationary pressures continued to be led by price movements linked to government, the “market goods and services ex volatile items index”, tracking private sector inflationary pressures, rose by 1.4% over the year, less than the 1.8% increase in headline inflation.

This measure excludes volatile price movement for items such as utilities, property rates and charges, child care, health, urban transport fares, postal services and education, among other areas.

Goods prices in this category rose by 1.5% over the year, slightly slower than the 1.6% increase for services.

Underlying CPI — of more importance when it comes to the outlook for Australian interest rate settings — rose by a smaller 0.4% during the quarter, leaving the annual increase at 1.77%.

The annual increase was in line with expectations. It also matched forecasts offered by the RBA in November.

However, as for evidence that core inflation is moving back towards the midpoint of the RBA’s 2-3% medium-term target, there was little evidence in the latest report with the annual rate actually decelerating a touch from the September quarter, leaving it at the lowest level since early 2017.

Underlying inflation has now undershot the RBA’s target for three years.

While similar trends in the past have seen the RBA look to bolster inflationary pressures by reducing official interest rates, Michael Blythe, Chief Economist at the Commonwealth Bank, doesn’t expect a similar policy response on this occasion despite financial markets thinking otherwise.

“The Q4 price readings revealed another in the long line of benign inflation outcomes. So in a sense today’s numbers are nothing new,” he said following the release of the report.

“Low inflation has been the norm from a market and policy perspective for a long time.”

As such, when the RBA releases its updated economic forecasts late next week, Blythe says it will likely retain the view that underlying inflation will gradually return to target.

“Today’s numbers do not provide any justification for changing the RBA’s medium term CPI projections,” he says.

“Any change must come indirectly via changes to growth, unemployment and wage forecasts. GDP projections need to be lowered. But a strong labour market cautions against being too heavy handed with the axe.

“If the RBA leaves GDP estimates beyond mid 2019 at 3% growth per annum, they can keep forecasts showing unemployment falling and wages rising… [and] credibly retain the line that the next rates move is probably ‘up’.”

However, not everyone is convinced that underlying inflation will return to target given recent trends.

“Given another quarter of modest core CPI growth it’s become harder to see the bank’s expectation of core inflation reaching 2% in Q2 2019 being realised,” says Kaixin Owyong, Economist at the NAB.

“This would require two quarters of 0.6% growth.”

Callam Pickering, APAC economist at global jobs specialists Indeed, is another who is sceptical about a pickup in underlying inflation ahead.

“The ducks are lining up for an Reserve Bank rate cut,” he said in response to the December report.

“Core inflation has eased again, rising at just 1.4% annualised rate over the past six-months. That is a mile from the RBA’s inflation target.”

Pickering says even the beat in headline CPI during the quarter was largely driven by just two components, alcohol and cigarettes.

“Alcohol and tobacco accounted for around half the increase in total inflation in the December quarter,” he said.

“It is concerning how narrow Australia’s inflation pulse is and that too points to ongoing weakness.”

Looking ahead, Pickering expects the RBA will downgrade its GDP growth and inflation forecasts in its quarterly statement on monetary policy released next Friday. He also notes that for the first time in a long while, the RBA’s separate monetary policy statement released next Tuesday will make for compulsory reading.

The hurdle for cutting rates remains high. There is a clear reluctance from those in charge to pull the trigger. But the flow of recent data is becoming more difficult to ignore. Whether it is inflation or house prices or business sentiment, they all point towards a slowing economy. An economy that may very well require lower interest rates.

“The Reserve Bank appears all but certain to downgrade their growth and inflation forecasts,” he says.

“They are unlikely to cut [the cash rate] in February but their statement will be the first in a long time that could be considered compulsory reading.

“The flow of recent data is becoming more difficult to ignore. Whether it is inflation or house prices or business sentiment, they all point towards a slowing economy. An economy that may very well require lower interest rates.”

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