Inflation bounce-back after historic decline

Consumer Price Index

Inflation: The Consumer Price Index (CPI) – the main measure of inflation in Australia – rose by 1.6 per cent in the September quarter (consensus: +1.5 per cent). The result follows the 1.9 per cent decline in the CPI in the June quarter – the biggest quarterly decline in 89 years. The June quarter result had been affected by the Federal Government decision to provide free child care and a 19.3 per cent fall in the cost of petrol. The temporary child care benefit has since ended while petrol prices rebounded over the September quarter.

Annual rate of inflation: In the year to September, the CPI rose by 0.7 per cent after falling 0.3 per cent in the year to June (consensus: +0.6 per cent).

Main changes: Notable price rises in the September quarter were: were child care; automotive fuel (+9.4 per cent); preschool and primary education (+11.1 per cent); furniture (+6.4 per cent); major appliances (+5.3 per cent); and small appliances (+5.8 per cent). Notable price falls in the September quarter were: water & sewerage (down 2.7 per cent); other non-durable household products (down 4.1 per cent); personal care products (down 3.0 per cent); telco equipment (down 0.8 per cent); urban transport fares (down 3.5 per cent); pharmaceutical products (down 2.1 per cent); ‘other food products (down 3.5 per cent); cakes and biscuits (down 1.4 per cent); takeaway and fast foods (down 0.7 per cent); and ‘other’ cereal products (down 4.3 per cent).

Underlying measures: The Reserve Bank monitors three measures to derive the underlying inflation rate. The trimmed mean rose 0.4 per cent in the September quarter (1.2 per cent annual); the weighted median rose by 0.3 per cent (1.3 per cent annual) and the CPI less volatile items rose by 1.3 per cent (0.9 per cent annual). Overall, underlying inflation was 0.4 per cent in the quarter and rose by around 1.25 per cent over the year. Market goods and services less volatile items rose by 0.5 per cent in the quarter to be up 1.7 per cent on the year.

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

What does it all mean?

• The June quarter CPI figures were historic. The last time consumer prices fell by 1.9 per cent over a quarter – that is, over a three month period – was in 1931. The September quarter CPI marks a partial return to ‘normality’. However we will only get a true sense of inflation and where prices are headed in 2021.

• Prices rebounded in the September quarter for a number of reasons – the end of subsidised child care and the rebound in petrol prices. But the best guide to underlying prices is the ‘trimmed mean’. This measure shows prices up 0.4 per cent in the quarter to be up 1.2 per cent over the year. So low annual inflation rules, not deflation.

• Inflation is likely to remain below the Reserve Bank’s 2-3 per cent target band for a few years. As a result the Reserve Bank commits to not increasing the cash rate for three years. In fact today’s inflation result doesn’t stand in the way of a further easing of monetary policy. On Melbourne Cup day the Reserve Bank is likely to cut the target rates for cash and 3-year bond yields from 25 basis points (quarter of a per cent) to 10 basis points. The RBA is also likely to commit to purchases of 5-10 year bond yields with the intention of driving longer-term yields lower.

• The economic recovery is underway. But with unemployment rate likely to hold near 6-7 per cent, wage growth should remain modest, as should inflation. The RBA would be hoping that further monetary policy easing – combined with fiscal stimulus – being applied in a recovering economy would have added stimulatory effect.

What do the figures show?

• Overall result: The Consumer Price Index rose 1.6 per cent in the September quarter (consensus: +1.5 per cent). The result follows the 1.9 per cent decline in the CPI in the June quarter – the biggest quarterly decline in 89 years. In the year to September, the CPI rose by 0.7 per cent after falling 0.3 per cent in the year to June (consensus: +0.6 per cent).

• Underlying measures: The Reserve Bank monitors three measures to derive the underlying inflation rate. The trimmed mean rose 0.4 per cent in the September quarter (1.2 per cent annual); the weighted median rose by 0.3 per cent (1.3 per cent annual) and the CPI less volatile items rose by 1.3 per cent (0.9 per cent annual). Overall, underlying inflation was 0.4 per cent in the quarter and rose by around 1.25 per cent over the year. Market goods and services less volatile items rose by 0.5 per cent in the quarter to be up 1.7 per cent on the year.

Capital cities: Sydney +1.8 per cent in the quarter (annual +0.7 per cent); Melbourne +0.9 per cent (+0.7 per cent); Brisbane +2.3 per cent (+0.6 per cent); Adelaide +1.0 per cent (+1.0 per cent); Perth +1.8 per cent (+1.3 per cent); Hobart +1.0 per cent (+1.7 per cent); Darwin +1.7 per cent (-0.4 per cent); Canberra +2.3 per cent (+1.0 per cent).

• Main Negative Contributors:

The Notable price falls in the September quarter were:

Food: “Falls of 3.5 per cent in other food products, 1.8 per cent in cakes and biscuits, 0.7 per cent in takeaway and fast foods, and 4.3 per cent in other cereal products were the main contributors. A return to regular discounting cycles after the peak COVID-19 stockpiling period drove the movement across a wide range of products.”

Furnishings, Household equipment & services: “Falls of 4.1 per cent in other non-durable household products and 3.0 per cent in personal care products…due to a return to discounting on products such as toilet paper and body washes.”

Housing: “A fall of 2.7 per cent in water and sewerage was driven by annual price reviews conducted across a number of capital cities. Rents fell in most capital cities due to continued weak rental market conditions and high vacancy rates arising from COVID-19. Rents recorded the first annual fall in the history of the series.”

Health: “A fall of 2.1 per cent in pharmaceutical products was the main contributor due to increases in the proportion of consumers who qualify for subsidies under the Pharmaceutical Benefits Scheme (PBS).”

Transport: “A 3.5 per cent fall in urban transport fares partially offset the rise, due to discounts for off-peak transport in Sydney.”

Communication: “A fall of 0.8 per cent in telecommunication equipment and services was the main contributor.”

• Main Positive Contributors:

Notable price rises in the September quarter were:

Food: “Rises of 2.6 per cent in beef and veal and 1.3 per cent in other meats”. And, “Producers responded to increased rainfall by restocking herds, causing a fall in supply, and strong global demand continued due to African swine fever.”

Alcohol and tobacco: “A rise of 3.2 per cent in tobacco was the main contributor, due to the 12.5 per cent annual excise indexation and bi-annual AWOTE increase on 1 September.”

Clothing & footwear: “A rise of 1.5 per cent in garments for women was the main contributor.”

Housing: “A rise of 0.5 per cent in new dwelling purchases by owner occupiers was driven by increases to base prices and reductions in the value of promotional offers. The rise was partially offset by the HomeBuilder and two state grants, which reduced out of pocket expenses for new dwelling purchases.”

Furnishings, Household equipment & services: “Rises of 6.4 per cent in furniture and 5.3 per cent in major household appliances were due to strong demand for products such as home office furniture and fridges and freezers, combined with supply constraints. Child care was the main contributor to the rise due to child care fees for Australian households returning to their pre-COVID-19 rate.”

Recreation & culture: “A rise of 1.6 per cent in audio, visual and computing equipment was due to strong demand for products such as sound bars and home theatre systems.”

Transport: “Rises of 9.4 per cent in automotive fuel and 2.5 per cent in motor vehicles were the main contributors.”

Education: “A rise of 11.1 per cent in preschool and primary education was the main contributor due to the ending of free before and after school care as part of the ‘Early Childhood Education and Care Relief Package’.”

• Prices of tradables: The tradables component of the ‘All groups CPI’ rose by 1.4 per cent to be unchanged over the year.

• Prices of non-tradables: The non-tradables component of the ‘All groups CPI’ rose by 1.6 per cent to be up 1.0 per cent over the year.

• 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?

• The Reserve Bank sets interest rates with a view of keeping inflation between 2-3 per cent over an economic cycle. Inflation is well below the lower bound of the range at present. And the expectation is that inflation will remain contained for some time. As a result, interest rates will spend an extended period at generational lows.

• Businesses that want an inflation guide for setting selling prices or rents are best advised to use the ‘trimmed mean’. The Reserve Bank expects annual trimmed (‘underlying’) inflation to be 1.25-1.50 per cent through to mid-2022.

• The underlying measure has now been below the Reserve Bank’s target for 19 successive quarters and while US stimulus is expected to eventually push inflation higher, the higher Aussie dollar could continue to keep a lid on prices with rental prices pressured lower by falling inbound migration.

Published by Craig James, Chief Economist, CommSec