Australia's patchwork inflation picture underlines the RBA's challenge on interest rates


Inflationary pressures, as a whole, are weak in Australia.

But in some parts of the country they’re weaker than others.

Nothing quite rammed home that point than yesterday’s December quarter consumer price inflation (CPI) report, in particular the table below from the Australian Bureau of Statistics (ABS).

Source: ABS

It shows both the quarterly and annual change in headline CPI by Australian capital city.

While from a national perspective, CPI increased by 1.9% over the year, that clearly was not representative of what was seen across the country.

In Adelaide, for example, CPI increased by 2.3% over the year, the fastest of any capital city. At the other end of the spectrum, CPI rose by just 0.8% in Perth, nearly three times as slow as its neighbour to the east.

In the southeastern capitals — Sydney, Canberra, Melbourne and Hobart — CPI rose by 2.1% or more over the year.

So what explains the wide divergence between the mining capitals — Perth and Darwin — to what was seen in the southeast of the country?

To Terry Rawnsley, Economist at SGS Economics and Planning, the split is largely explained by varying economic conditions across the country, in particular labour market strength.

“Sydney and Melbourne’s GDP growth rates are both around 3.0%, while Perth was in a recession during 2016-17 with a decline in GDP of 3.5%,” he says.

“So it is no surprise that inflation remains so weak in Perth.”

And with economic conditions stronger in the east and weaker in the west, Rawnsley says this initially attracted workers to the eastern seaboard.

However, he says there signs interstate migration is now slowing to these capitals, contributing to shortages of workers in some industries which, in turn, is starting to translate to a pickup in wage pressures.

“Both Sydney and Melbourne have benefited from an influx of skilled labour moving from Western Australia and a lesser extent Queensland. This has help to fill vacancies in key industries including construction,” he says.

“That migration pattern now appears have slowed so labour shortages are expected to increase in Sydney and Melbourne which will start to feed into inflation pressures over the next year.

Kristina Clifton, Economist at the Commonwealth Bank, largely agrees with Rawnsley’s view.

“Annual inflation in most of the East Coast cities is running above 2%, in part due to stronger jobs and housing markets,” she said following the release of the CPI report.

“Inflation in Perth and the Nothern Territory is very soft. As the Western Australian economy continues to recover from the downturn in mining investment we can expect some stronger prices pressures to emerge.”

So economic conditions largely explain the divergence in inflationary pressures seen across the country over the past year.

Along with explaining what’s been seen recently, it also underlines the challenge the Reserve Bank of Australia (RBA) faces when it comes to monetary policy.

The Australian economy is not uniform in nature, having pockets of strength and weakness at the same time.

The RBA has to weigh up what’s best for the entire Australian economy, rather than what’s appropriate for individual locations.

That was seen first hand during Australia’s twin mining booms either side of the global financial crisis, seeing policy largely set to curb booming levels of activity in the mining states and territories, probably to the detriment of non-mining regions that could probably have done with lower interest rates.

Now the opposite outcome is occurring, with policy largely being dictated by non-mining areas of the economy to the disadvantage of mining regions.

To Rawnsley, in a hypothetical world, interest rates would be set for individual states and territories, or for specific capital cities.

“The current RBA interest rate is too low for Sydney and Melbourne and too high for most of the rest of the country,” he says.

Pointing to the table below, Rawnsley says this likely reflects where interest rates for individual capital cities would be set given current economic trends, at least in his opinion.

Source: SGS Economics & Planning

From 3.75% in Sydney to 0.25% in a variety of locations, and a mixed bag in between.

But this is hypothetical. The reality is the RBA can’t do this.

However, what it helps to demonstrate is that with economic conditions now stronger in east and starting to strengthen in the west, if the current trends continue it will be a case of when — not if — the RBA will start to lift interest rates.

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.