Australian inflation has now undershot expectations for two full years

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  • Both headline and underlying inflation undershot expectations in the September quarter, all but ensuring official interest rate settings will be left at current levels for the foreseeable future.
  • Underlying inflation has now come in under the RBA’s 2-3% inflation target for 11 consecutive quarters. Of more concern, it’s now moving further away from the RBA’s target.
  • At 0.32%, the quarterly increase in underlying inflation was the weakest since the March quarter of 2016. Back then, the RBA cut interest rates twice within three months in response to the inflation miss.

Australian inflationary pressures moderated in the September quarter, all but ensuring official interest rate settings will be left at current levels for the foreseeable future.

According to the Australian Bureau of Statistics (ABS), headline consumer price inflation (CPI) grew by 0.4% in the three months to September, and by 1.9% over the year.

The quarterly figure was below market expectations for an increase of 0.5%, continuing the pattern seen each and every quarter over the past two years.

Headline CPI previously grew by 0.4% in the June quarter, and by 2.1% over the year.

“Modest rises in housing costs, including rents, utilities and property rates, and a fall in child care out-of-pocket expenses, saw a subdued rise in the CPI this quarter,” said Bruce Hockman, Chief Economist at the ABS.

The ABS said the largest price increases last quarter were for international holiday travel and accommodation, tobacco, property rates and charges, automotive fuel and fruit, partially offset by price falls for child care and telecommunications equipment and services.

“Child care [fell 11.8% over the quarter] following the introduction of the Child Care Subsidy on 2 July, which replaced the Child Care Rebate and Child Care Benefit,” the ABS said.

This table from the ABS shows both the quarterly and year-ended change in prices across the capital cities by individual grouping.

ABS

In what is a switch to what has been seen over recent years, the most acute price pressures during the quarter came from tradable items, those influenced by offshore factors.

“The tradables component of the CPI rose 0.8% in the September quarter,” the ABS said.

“The tradable goods component rose 0.4% due to automotive fuel, fruit, furniture and vegetables. The tradable services component rose 4.0% due to international holiday travel and accommodation.”

In contrast, non-tradable items — accounting for around 60% of the entire CPI basket — grew by just 0.3% last quarter, driven by price increases for tobacco, beer, takeaway and fast food, domestic holiday travel and accommodation along with property rates and charges.

From a year earlier, tradable inflation grew by 1.4%, below the 2.2% increase in non-tradable items.

While there’s still a noticeable gap between the two, it has narrowed sharply compared to levels seen in recent years, partially reflecting the impact of the weaker Australian dollar and strength in global crude prices.

By individual capital city, there was once again a noticeable divergence in inflationary pressures with those locations where economic conditions are stronger seeing inflation increase at a faster pace over the past year compared to those where conditions are weaker.

Year-ended CPI ranged from 2.7% in Hobart to as little at 1.2% in Perth.

Sydney, Melbourne and Canberra — also located in Australia’s southeastern corner — saw CPI increase by 2% or more over the past year.

Darwin, like Perth a mining capital, saw prices lift by just 1.3%.

ABS

Indicating that inflationary pressures continue to be driven by price movements linked to government, the “market goods and services ex volatile items index,” tracking private sector inflationary pressures, grew by just 0.5% over the quarter and 1.1% over the year.

This reading 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.

Good prices in this category grew by 0.9% over the year, while those for services increased by a faster 1.5%. The latter was the fastest increase since late 2015.

Underlying inflation — which removes volatile price movements and is more influential on the outlook for official interest rate settings — rose by 0.32% for the quarter after seasonal adjustments, leaving the increase over the year at 1.75%.

Markets had been expecting a quarterly increase of 0.4%, leaving the year-ended rate at 1.9%.

The quarterly increase was the weakest since the March quarter of 2016. Back then, in response to the weak inflation report, the RBA subsequently cut is cash rate twice in the following three months.

The annual rate was also the lowest since the March quarter last year.

Despite the undershoot in the year-ended underlying CPI rate, the RBA was expecting underlying inflation to moderate, forecasting that it would end 2018 at 1.75%

However, as seen in the chart below, the annual rate has now undershot its 2-3% medium-term inflation band for 11 consecutive quarters, creating renewed doubt as to whether it will climb back above 2% in the coming years as the RBA currently expects.

Of concern, it’s now moving further away, not closer to, the midpoint of the RBA’s target.

Despite the undershoot on both the headline and underlying inflation readings last quarter, Paul Dales, Chief Australia and New Zealand Economist at Capital Economics, says it’s unlikely to scare the RBA, at least not yet.

“The further dip in the average of the trimmed mean and weighted median measures of underlying inflation [was more worrying],” he said.

“Admittedly, the RBA had expected underlying inflation to fall back to 1.75% in Q4, so it may have just happened a bit earlier. But our hunch is that the downward influence on underlying inflation is bigger than the RBA had expected.”

Mirroring the reaction of financial markets, Dales says today’s report means it’s highly unlikely the RBA will be in a position to lift official interest rates until 2020 at the earliest.

“These figures support our view that underlying inflation will stay below the RBA’s 2-3% target for at least another two years,” he says.

“As such, we doubt the RBA will raise rates from 1.5% until late in 2020.”

With the CPI report out of the way, attention will now turn to the release of Australia’s Q3 Wage Price Index in the middle of next month.

Speaking in February this year, RBA Governor Philip Lowe suggested that annual wage growth in the vicinity of 3.5% would likely be required to keep inflation steady at the mid-point of the bank’s 2-3% target.

In the year to June, it grew at an annual pace of just over 2.1%.

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