- RBA deputy governor Guy Debelle has given a detailed assessment of the forces behind low inflation in Australia.
- Competition in retail, low inflation for housing rentals and low wage growth were cited as three key factors.
- Debelle reiterated the RBA expects inflation growth will return to the 2-3% target range, although it “would like to be more confident” that growth is sustainable.
Inflation growth in Australia remains weak. And RBA deputy governor Guy Debelle highlighted a number of reasons why in a speech today at The Economic Society of Australia.
Debelle also reiterated that the central bank expects inflation to return to the low end of its 2-3% target range by 2020.
However, “we would like to be more confident that inflation will be sustained at a rate consistent with the target”, he said.
High competition in the retail sector, historically low rental growth and consistently low wage growth were highlighted as three key factors behind softer inflation growth.
In addition, “utilities prices have been boosting inflation for a number of years but are now expected to reduce it in the period ahead”.
The expected fall in electricity prices was the main reason the RBA dropped its 2018 inflation forecast to just 1.75% earlier this month.
On retail — around 30% of the CPI basket — Debelle noted that on average, prices have actually fallen since 2015. In other words, deflation has come to the sector.
“How retail competition plays out over the period ahead is one of the uncertainties for the Bank’s inflation forecast,” he said.
For one thing, its allowed foreign retailers better access to the market. While online sales make up just 5% of total retail sales, they are currently growing at an annual rate of 50%.
And despite the increased competition in the sector, “other entrants who are only just establishing their foothold” (hint — Amazon), indicates the sector still offers attractive margins.
While competition has played a role, Debelle also cited the influence of technology. Particularly for audio and electronic products, which are are now falling at around 5%. Those falls alone take 0.2% off annual CPI growth.
Debelle also cited the drag on inflation from falling rental costs.
“The pace of rent inflation has been falling since 2008, and year-ended rent inflation is around its lowest level since the mid 1990s,” Debelle said.
Like electronic products, that fact alone also takes another 0.2% off the annual inflation print.
Debelle said falling rent inflation had coincided with a residential construction boom which increased vacancy rates — a trend which is unlikely to continue.
“We expect the pace of rent inflation to increase gradually over the next couple of years. However, it will take some time for the flow of new rents to materially affect the stock of rents captured in the CPI,” he said.
“More recently, wages growth has been subdued, and this has been a significant factor contributing to the slower pace of market services inflation,” Debelle said.
“Market services” are defined as discretionary items such as dining out or getting a haircut, as opposed to utility prices such as electricity.
Debelle repeated the RBA’s relatively optimistic assessment that wage growth will eventually rise as the labour market continues to tighten.
However, he highlighted the outlook for underemployment — cited as a key factor by many economists as the key driver for wage growth — remains unclear.
“There is considerable uncertainty about the extent of unutilised capacity in the labour market and how quickly a reduction in spare capacity would translate into higher wage and price inflation.”
Ultimately, Debelle said the Australian economy remains on the same path it’s been for the last 12-18 months.
“Although inflation is likely to be a bit lower in the near term, this is expected to be temporary,” he said.
“Further gradual progress on both lowering unemployment and bringing inflation closer to the midpoint of the target is expected over coming years.”
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