Highest annual headline inflation in 5½ years

Consumer Price Index

Inflation: The Consumer Price Index – the main measure of inflation in Australia – rose by 0.3 per cent in the March quarter (consensus: 0.2 per cent). In seasonally adjusted terms the CPI rose by 0.4 per cent. The annual rate of headline inflation lifted from 1.8 per cent to 2.2 per cent – the strongest pace in 5½ years.

Underlying measures: The Reserve Bank monitors three measures to derive the underlying inflation rate. The trimmed mean rose by 0.5 per cent in the March quarter (1.8 per cent annual); the weighted median rose by 0.5 per cent (1.7 per cent annual) and the CPI less volatile items rose by 0.5 per cent (2.1 per cent annual). Overall, underlying inflation rose by around 0.5 per cent in the quarter and by around 1.7 per cent over the year. Market goods and services less volatile items rose by 0.3 per cent in the quarter to be up 2.1 per cent on the year.

Main changes: The most significant price rises in the March quarter were for food and non-alcoholic beverages (+1.9 per cent); alcohol and tobacco (+1.6 per cent); education (+2.6 per cent); and health (+1.7 per cent). The most significant offsetting price falls this quarter are automotive fuel (-6.0 per cent); domestic holiday travel and accommodation (-3.1 per cent); and international holiday travel and accommodation (-3.0 per cent).

Notable lows in prices: Audio visual equipment (39½-year low); audio visual services (30½-year low); telecom equipment (36-year low); communications (near 34-year low). Other recreational, sporting & cultural services (cinemas, museums etc.) slowest annual pace in prices on record (21 years).

Notable price increases: Annual food inflation is the highest in 5½ years, up 3.2 per cent over the year. Drought and bushfire effects are apparent in bread & cereals (+3.8 per cent, fastest rate in 11 years); meat & seafood (+5.6 per cent, equal fastest rate in almost 11 years); pork (+8.5 per cent, fastest pace in 14½ years); milk (+7.7 per cent, fastest in 11½ years); cheese (+6.6 per cent, fastest rate in 5½ years); eggs (+6.8 per cent, fastest in 5½ years); snacks (+2.8 per cent, fastest in 7 years). And shoe prices rose at an annual growth rate of 3.7 per cent (fastest rate in 8 years) and while cleaning products lifted 3.5 per cent (fastest pace in 7 years).

The inflation data is pivotal in Reserve Bank interest rate deliberations.

What does it all mean?

• Aussies venturing out to buy essentials at supermarkets during the peak of the coronavirus (COVID-19) crisis would’ve noticed that food had become more expensive. In fact, prices of food and non-alcoholic beverages surged at an annual growth rate of 3.2 per cent in the March quarter – the strongest rate in 5½ years – propelling overall headline consumer prices higher. Why? Supply shortages due to the drought and bushfires – fruit and vegetable prices lifted sharply.

• The Bureau of Statistics said, “There were some price effects of COVID-19 apparent in the March quarter due to higher purchasing of certain products towards the end of the quarter, as restrictions came into effect. Most notably, rises were seen in, other non-durable household products (+3.4 per cent), which includes toilet paper; personal care products (+2.2 per cent), which includes soap and hand sanitiser; and other cereal products (+4.4 per cent), which includes rice and pasta.”

• The lift in grocery prices broadly aligns with Coles’ sales report today. The supermarket chain not only reported a record 12.9 per cent lift in sales to $9.2 billion during the March quarter, but it also announced that its grocery and food prices rose by 2.6 per cent during the quarter, or by 1.8 per cent excluding tobacco and fresh foods. Why? COVID-19 panic buying saw a surge in shopper demand so the company scaled-back promotional activity with consumers preferring to purchase smaller grocery pack sizes in the frenzy.

• But before anyone gets too excited about the headline annual inflation rate hitting the lower end of the Reserve Bank’s 2-3 per cent target band, the demand shock from the virus crisis is about to plunge Australia into the deflationary world, a world experienced by Japan and Europe in recent years. In fact, Reserve Bank Governor Philip Lowe warned last week that, “it is quite likely that year-ended headline inflation will turn negative in June. If so, this would be the first time since the early 1960s that the price level has fallen over a full year.”

• A sharp decline in crude oil and petrol prices, supportive government measures to cap and reduce prices – such as free childcare – tepid wage growth and weaker home rental prices are all likely to be disinflationary. Given the size of the housing cost basket within the consumer price index – around 23 per cent – falling home prices, higher vacancy rates and weaker rents could persist for the rest of 2020, weighing on consumer prices.

What do the figures show?

• The Consumer Price Index – the main measure of inflation in Australia – rose by 0.3 per cent in the March quarter (consensus: 0.2 per cent). In seasonally adjusted terms the CPI rose by 0.4 per cent. The annual rate of headline inflation lifted from 1.8 per cent to 2.2 per cent – the strongest pace in 5½ years.

• The Reserve Bank monitors three measures to derive the underlying inflation rate. The trimmed mean rose by 0.5 per cent in the March quarter (1.8 per cent annual); the weighted median rose by 0.5 per cent (1.7 per cent annual) and the CPI less volatile items rose by 0.5 per cent (2.1 per cent annual). Overall, underlying inflation rose by around 0.5 per cent in the quarter and by around 1.7 per cent over the year. Market goods and services less volatile items rose by 0.3 per cent in the quarter to be up 2.1 per cent on the year.

• Capital cities: Sydney +0.3 per cent in the quarter (annual +2.0 per cent); Melbourne +0.8 per cent (+2.7 per cent); Brisbane -0.1 per cent (+1.8 per cent); Adelaide +0.3 per cent (+2.4 per cent); Perth +0.4 per cent (+2.1 per cent); Hobart +0.4 per cent (+3.4 per cent); Darwin +0.3 per cent (+1.5 per cent); Canberra +0.4 per cent (+2.0 per cent).

• Main Positive Contributors:

The most significant price rises in the March quarter were for food and non-alcoholic beverages (+1.9 per cent), alcohol and tobacco (+1.6 per cent), education (+2.6 per cent) and health (+1.7 per cent).

Food and non-alcoholic beverages: The ABS reported, “Rises of 6.0 per cent in fruit and vegetables and 2.0 per cent in meat and seafood were the main contributors. Drought conditions saw price rises in fruit, vegetables, dairy, grain and cereal products in the March quarter. Bushfires increased transport costs for some fresh produce and strong export demand combined with falling supply resulted in further price rises for meat. Increased spending in response to COVID-19 towards the end of the quarter saw price pressures for a range of food products due to high demand and less discounting.”

Education: “Rises of 3.4 per cent in secondary education and 2.9 per cent in preschool and primary education were the main contributors following the commencement of the new school year”, according to the ABS.

Health: The ABS said, “Rises of 5.1 per cent in pharmaceutical products and 1.1 per cent in medical and hospital services were the main contributors. March quarters typically see a reduction in the proportion of consumers who qualify for subsidies under the Pharmaceutical Benefits Scheme (PBS) and Medicare Benefits Scheme (MBS). The safety net thresholds for both the PBS and MBS were reset on 1 January.”

• Main Negative Contributors:

The most significant offsetting price falls this quarter are automotive fuel (-6.0 per cent), domestic holiday travel and accommodation (-3.1 per cent) and international holiday travel and accommodation (-3.0 per cent).

Automotive fuel: The ABS reported, “A 6.0 per cent fall in automotive fuel was the main contributor as recent falls in world oil prices flowed through to fuel prices. Automotive fuel fell in January (-0.8 per cent), February (-3.4 per cent) and March (-9.3 per cent).”

Domestic & international holiday travel and accommodation: “Falls of 3.1 per cent in domestic holiday travel and accommodation and 3.0 per cent international holiday travel and accommodation were the main contributors. This was due to weak demand in domestic accommodation and the winter off-peak season in Europe and America”, according to the ABS.

• Prices of tradables: The tradables component of the ‘All groups CPI’ fell by 0.2 per cent in the March quarter, but was still up 2.1 per cent over the year. The tradable goods component rose 0.2 per cent mainly due to vegetables (+9.1 per cent).

• The tradable services component fell 2.9 per cent mainly due to international holiday, travel and accommodation (-3.0 per cent).

• Prices of non-tradables: The non-tradables component of the ‘All groups CPI’ rose 0.6 per cent in the March quarter to be up 2.3 per cent over the year. Non-tradable goods component rose 1.2 per cent, mainly due to tobacco (+2.0 per cent).

• Non-tradable services component rose 0.4 per cent mainly due to secondary education (+3.4 per cent).

• In seasonally adjusted terms, the tradables component of the ‘All groups CPI’ rose 0.1 per cent and the non-tradables component rose 0.6 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.

What is the importance of the economic data?

• 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 (RBA) 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 RBA may elect to raise interest rates in order to constrain price pressures. Conversely, if inflation is low and expected to remain low, the RBA may elect to cut interest rates if it believes the growth pace of the economy is in need of strengthening.

What are the implications for interest rates and investors?

• Notable COVID-related price impacts to show up so far include the rising cost of cleaning products and decline in admission costs for cinemas, theatres, concerts, museum, theme and amusement parks due to a decline in demand due to social distancing measures.

• Slow wage growth and falling prices of consumer goods – such as electronics, communications and clothing – have been a notable feature of low-inflation for several years now. And businesses have been reluctant to pass on the rising cost of imported goods (due to the weaker Aussie dollar) amid consumer spending caution and intense competition. Consumers – while currently shopping online at home – are continuing to enjoy the lowest technology and communications equipment prices over the past 40 years. And recent heavy rainfall on the East Coast – easing drought conditions – should see food prices ease.

• The huge impact of the economic shutdown will see deflation persist for several quarters, despite expectations that government social distancing restrictions could eventually be removed by year-end as the severity of the pandemic subsides. In fact, Commonwealth Bank Group economists are forecasting the annual headline rate to fall to just 0.5 per cent in 2020 after turning negative in the June quarter. But the annual underlying inflation measure (trimmed mean) is estimated to hold up at 1.3 per cent in 2020.

• The Reserve Bank Board meets on Tuesday and is expected to leave targets for both the cash rate and 3-year Commonwealth Government Bond yield at 0.25 per cent. The quarterly Statement on Monetary Policy is released on May 8. It is a difficult time to forecast, but investors will be looking to guidance from the Board, even if the forecasts are only expressed in broad ranges.

Published by Ryan Felsman, Senior  Economist, CommSec