The Consumer Price Index – the main measure of inflation in Australia – was unchanged in the December quarter. It was the lowest quarterly inflation reading for three years.
- In seasonally adjusted terms the CPI rose by 0.2 per cent – in line with economist forecasts. The CPI stands 3.0 per cent higher than a year ago.
- Underlying inflation rose 0.5 per cent over the quarter to be up 2.6 per cent on the year. The Reserve Bank monitors three measures to derive the underlying inflation rate. The trimmed mean rose 0.6 per cent in the December quarter; the weighted median rose by 0.5 per cent and the CPI less volatile items rose by 0.3 per cent.
- There were some historical falls in a raft of items: Household appliances ranging from fridges to kettles fell by 3.4 per cent in the quarter – the biggest quarterly fall in records going back 40 years.
- Reserve Bank tipped to cut rates: The low inflation reading paves the way for the Reserve Bank to cut rates by 25 basis points on February 7.
What does it all mean?
As we have suggested in a number of recent reports, inflation is well and truly contained. The latest result removes the last standing hurdle for the Reserve Bank to cut interest rates next month. The sluggishness in the domestic economy has ensured that businesses continue to absorb any increases in costs, while the strength of the Australian dollar continues to keep imported prices low. In addition the uncertainty and downside risks to the global economy have resulted in subdued commodity price in recent months.
There plenty of reasons for the average Aussie consumer to celebrate the fall in prices for an array of household appliances including fridges, washers and toasters. Not only have these goods recorded the biggest price fall in 40 years, but diary prices have recorded the biggest fall in 38 years, while chips and chocolates have recorded the smallest rise in prices in 22 years.
Inflation was unchanged in the December quarter and even if you account for seasonal factors, inflation rose by just 0.2 per cent. The producer price data earlier in the week highlighted that retailers and service orientated sectors have been falling over themselves to trim prices in order to get consumers to spend. And given that consumers will continue to press for bargains it would have been difficult to believe that inflation will be a problem over the coming year.
Not only was the headline inflation rate virtually flat, but the closely-watched underlying measures also recorded decidedly subdued readings. In addition annualised underlying inflation remains solidly in the middle of the Reserve Banks 2-3 per cent target band. In fact the average of the three key underlying inflation measures stands at 2.6 per cent.
It’s clear that domestic inflation is unlikely to stand in the way of a rate cut next month. However the Reserve Bank is well aware of the increase in bank funding costs and as such a rate cut next month is unlikely to be the last in the current cycle. This is especially the case if it is not all passed on by the domestic banks. It important to remember that interest rates are modestly above neutral and given the downside risks to the global economy, the Reserve Bank is likely to take out an added level of insurance over the next couple of months.
It’s great news for homeowners and great news for potential homebuyers. The likelihood of further rate cuts should help to alleviate pressures on household budgets and stimulate activity in the housing sector.
Retailers have reason to cheer the latest inflation result. If the Reserve Bank cuts rates as expected, this should serve to boost consumer confidence as well as the purchasing power of Aussie consumers. On the sharemarket, retailers, housing-dependent stocks and industrials have the most to gain from lower interest rates and thus lower borrowing costs.
Surprisingly financial markets had a downbeat reaction to the inflation data, taking the view that the Reserve Bank was less likely to cut rates. Clearly traders and analysts need to take a closer look at the figures.
What do the figures show?
- The All Groups Consumer Price Index (CPI) rose by 0.2 per cent in seasonally adjusted terms in the December quarter after rising by 0.5 per cent in the December quarter. In original terms the CPI index was flat in the December quarter.
- In the December quarter the ABS notes that “The most significant price rises this quarter were for domestic holiday travel and accommodation (+7.3 per cent), rents (+1.0 per cent), telecommunication equipment and services (+1.1 per cent), beer (+1.2 per cent) and automotive fuel (+0.7 per cent). The most significant price falls this quarter were for fruit (–13.4 per cent), pharmaceutical products (–5.6 per cent), vegetables (–5.0 per cent), audio, visual and computing equipment (–3.4 per cent), international holiday travel and accommodation (–1.9 per cent) and motor vehicles (–1.2 per cent).
- The annual rate of inflation fell from 3.5 per cent in the June quarter to 3.1 per cent in the December quarter.
- Underlying measures of inflation were modestly higher in the December quarter. The weighted median measure rose by 0.5 per cent in the quarter, with the annual rate falling from 2.7 per cent to 2.6 per cent. The trimmed mean measure rose by 0.6 per cent in the quarter with the annual rate rising from 2.4 per cent to 2.6 per cent. And CommSec estimates that the CPI excluding fruit, vegetables, petrol and deposit and loan facilities (CPIX) rose by just 0.3 per cent in the quarter with the annual rate rising from 2.3 per cent to 2.5 per cent.
- Prices of tradables fell by 1.2 per cent in the December quarter, with lower fruit price, pharmaceutical products, vegetables, audio, visual and computing equipment, motor vehicles and accessories, partially offset by automotive fuel, audio, visual and computing media and services and tobacco. The annual growth rate of tradables fell from 3.3 per cent to 1.8 per cent.
- Prices of non-tradables rose by 0.8 per cent in the December quarter. Price increases for beer, new dwelling purchase by owner–occupiers, electricity, and take away and fast foods drove the higher result. The annual rate of non-tradables inflation rose from 3.4 per cent to 3.9 per cent in the December quarter.
- 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 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 for interest rates and investors?
The past two rate cuts have yet to have a significant impact on the economy. If anything the rates cuts have improved activity levels at the margin. And while the impact of the rate cuts will continue to support activity levels over the next few months more needs to be done.
The domestic economy is still patchy, consumers are remaining cautious and businesses are finding trading conditions very difficult. And as long as consumers remain conservative and businesses have to shave margins to move stock then underlying inflation should remain within the Reserve Bank’s target band of 2-3 per cent.
The latest inflation data removes the last hurdle to cut interest rates further in the next couple of months. In addition interest rates are still modestly above long term averages and as such it is likely that the Reserve Bank will cut interest rates by 25 basis points next month.