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Inflation stubbornly below Reserve Bank targetConsumer price index
Inflation: The Consumer Price Index – the main measure of inflation in Australia – rose by 0.6 per cent in the December quarter, below expectations for a lift of 0.7 per cent. In seasonally adjusted terms the CPI rose by 0.6 per cent. The annual rate of inflation rose from 1.8 per cent to 1.9 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 (1.8 per cent annual); the weighted median rose by 0.4 per cent (2.0 per cent annual) and the CPI less volatile items rose by 0.3 per cent (1.9 per cent annual). Overall, underlying inflation rose by 0.4 per cent in the quarter and by 1.9 per cent over the year (The Reserve Bank would call this “around 2 per cent”). Market goods and services less volatile items rose 0.4 per cent in the quarter to be up 1.1 per cent on the year.
Main changes: Petrol rose by 10.4 per cent in the December quarter with tobacco up 8.5 per cent, domestic holiday travel & accommodation up 6.3 per cent and fruit up 9.3 per cent. International holiday travel & accommodation fell 1.7 per cent with audio visual and computing equipment down 3.5 per cent and telecom equipment and services down by 1.4 per cent.
Prices of a raft of items are at the lowest levels for around 30 years: Women’s clothing is the cheapest levels in 28 years; car prices are at the lowest levels in 30 years; audio, visual & computing equipment is the cheapest on record (37 years). Men’s clothing prices have recorded the biggest drop in 27 years. 
What does it all mean?
It doesn’t get much better. Inflation is still under control. Interest rates are at record lows. Affordability of key staples is the best it has ever been. The job market is strengthening. And the record economic expansion continues.
Inflationary pressures remain subdued so the Reserve Bank will remain on the sidelines for some time yet. But there was a modest lift in the rate of annual headline inflation, finishing a touch below the Reserve Bank’s forecast of 2.0 per cent for 2017. Petrol, tobacco, fruit and domestic travel and accommodation prices all rose over the quarter. Though this was partially offset by the continued decline in computing and telecommunications-related goods and services prices.
Underlying inflation – which excludes the more volatile energy and food components – also remained below the Reserve Bank’s target band of 2-3 per cent. But the 2017 annual print was a touch above the Board’s 1.75 per cent forecast. And underlying inflation looks well placed to be a touch above the Reserve Bank forecast for 2018 of 1.75 per cent. Still, not enough to prompt any action on interest rates.
The Reserve Bank is maintaining a conservative outlook on inflation. Underlying inflation is not forecast to reach 2.0 per cent until 2019. This view is largely due to increasing uncertainty about the size and timing of how wage pressures might eventually pass through to consumer prices.
Wages growth remains near record lows due to structural changes in the labour market. Global competition, increased automation, decreased unionisation, reduced collective bargaining and the increased casualisation of the workforce have largely contained pay increases. Labour productivity is at five year lows in Australia, despite technological advances.
Also, the labour market is tightening with a staggering 403,100 jobs created in 2017. Job growth is the best in over 12 years and a whopping 75 per cent of jobs created in 2017 were full-time jobs. The unemployment rate is at 4-year lows and hours worked are growing at the fastest pace in six years.
Businesses conditions are the best in almost a decade and profitability is near record highs. We expect strong hiring, increased profits and emerging skills shortages to eventually lead to wage increases. Demographics could also work in workers’ favour with the Baby Boomers retiring en-masse, creating potential labour shortages.
The Reserve Bank recently stated that, “difficulty forecasting the persistence and intensity of competitive pressures presents another significant uncertainty for the inflation forecasts.” Indeed, increased global competition and aggressive discounting by new retail entrants, such as Amazon, Uniqlo, H&M and Zara, present significant obstacles to Aussie ‘bricks and mortar’ department stores – serving to reduce the prices of everyday goods.
The ratio of wages to prices over the past five years shows that affordability of communications, household appliances, clothing, cars and food have all increased markedly. In other words, consumers are the beneficiaries of goods deflation, despite stagnant income growth.
CommSec expects the Reserve Bank to stay on the interest rate sidelines until late in 2018.
What do the figures show?
The Consumer Price Index – the main measure of inflation in Australia – rose by 0.6 per cent in the December quarter, below expectations for a lift of 0.7 per cent. In seasonally adjusted terms the CPI rose by 0.6 per cent. The annual rate of inflation rose from 1.8 per cent to 1.9 per cent.
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 (1.8 per cent annual); the weighted median rose by 0.4 per cent (2.0 per cent annual) and the CPI less volatile items rose by 0.3 per cent (1.9 per cent annual). Overall, underlying inflation rose by 0.4 per cent in the quarter and by 1.9 per cent over the year (The Reserve Bank would call this “around 2 per cent”). Market goods and services less volatile items rose 0.4 per cent in the quarter to be up 1.1 per cent.
Petrol prices rose by 10.4 per cent in the December quarter with tobacco up 8.5 per cent and domestic holiday travel & accommodation up 6.3 per cent. Fruit prices surprised, rising by 9.3 per cent (higher prices for berries and grapes).
Conversely, international holiday travel & accommodation prices fell by 1.7 per cent with audio visual and computing equipment down 3.5 per cent and telecom equipment and services down by 1.4 per cent.
Prices of tradables rose by 0.5 per cent in the December quarter. According to the Bureau of Statistics: “The tradable goods component rose 0.7 per cent mainly due to automotive fuel (+10.4 per cent) and fruit (+9.3 per cent). The tradable services component fell 1.7 per cent due to international holiday travel and accommodation (-1.7 per cent).”
Prices of non-tradables rose by 0.8 per cent in the December quarter. According to the Bureau of Statistics: “The non-tradable goods component rose 1.4 per cent, mainly due to tobacco (+8.5 per cent) and new dwelling purchase by owner-occupiers (+0.6 per cent). The non-tradable services component rose 0.4 per cent, mainly due to domestic holiday travel and accommodation (+6.3 per cent) and insurance (+1.8 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 twelve months, the tradables component fell by 0.3 per cent, while the non-tradables component rose by 3.1 per cent.
Capital cities: Sydney +0.7 per cent in the quarter (annual +2.2 per cent); Melbourne +0.7 per cent (+2.2 per cent); Brisbane +0.8 per cent (+1.9 per cent); Adelaide +0.7 per cent (+2.3 per cent); Perth +0.4 per cent (+0.8 per cent); Hobart +1.0 per cent (+2.1 per cent); Darwin +0.3 per cent (+1.0 per cent); Canberra +0.6 per cent (+2.2 per cent).
Across the capital cities the largest contributors to price gains over the December quarter:
Sydney – petrol (+12.0 per cent);Melbourne – petrol (+10.6 per cent);Brisbane – petrol (+10.6 per cent);Adelaide – tobacco and petrol (+9.0 per cent each);Perth – petrol, domestic holiday travel & accommodation and tobacco (+8.4 per cent each);Hobart – domestic holiday travel & accommodation (+18.4 per cent);Darwin – tobacco (+8.9 per cent);Canberra – petrol (+8.9 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?
There has been a lot of focus on cost of living pressures, especially as we return to work and the kids return to school. Of course, pump prices – as CommSec has flagged for several months now – have lifted to around 3-year highs. This is largely attributable to rising global oil prices.
Tobacco prices – which only impact a small proportion of Aussies these days – also rose due to the federal excise tax increase of 12.5 per cent. Education-related costs have risen by 3.2 per cent annually. Health care premiums – also in the news in recent days – increased by 4.0 per cent in 2017.
That said, a raft of goods prices have declined to record or near-record lows, boosting the hip pocket of Aussie consumers. Major household appliances are the cheapest in 31 years, car prices are the lowest in 30 years, women’s clothing prices are at 28 year lows and men’s clothing prices fell by the most in 27 years last year. And technology and communications goods prices are at record lows, offsetting some of those rising school tuition fees.
So while wages growth remains stagnant at present, we’re still ahead. Real wages growth remains positive, but only just. The Reserve Bank will want to see some more evidence of firmer wages growth before feeling comfortable enough to lift interest rates. Underlying inflation has now under-shot its target for nine consecutive quarters.
The high-flying Aussie dollar, up by around 7 per cent against the greenback since December, could also complicate the Reserve Bank’s inflation outlook. Its strength makes imports cheaper, putting a lid on tradable good inflationary pressures in early 2018.
CommSec expects the cash rate may remain stable until at least December.
Originally published by Ryan Felsman, Senior Economist, CommSec