Forget fuel spike – tame underlying inflation means no price fears for RBA

A surge in the cost of fuel (up 7.6 per cent) helped drive  a 1.2 per cent spike in headline inflation in the September quarter.

But if you want a clue to what the Reserve Bank of Australia will make of the Consumer Price Index, focus on the measures of underlying inflation, when the quarterly rise was a more moderate 0.65 per cent.

As a result, underlying inflation is sitting around 2.3 per cent – virtually bang on the RBA’s forecast.

There are a few things for the central bank to keep an eye on.

One is the growth in house prices as the long-awaited recovery in the housing market gathers pace. While slow wages growth may help constrain inflation in real estate, the RBA will be increasingly alert as time goes on to the risk (remote for now) that if interest rates are kept low for too long they could fuel risky borrowing. But this is a problem that is a long way off. Economics conditions are still too soft for there to be talk of a rate rise just yet.

The other main factor is the lower exchange rate, and the effect that has had on push up the cost of imports.

If, as expected,  the US recovery gradually reasserts itself after the debt ceiling madness of recent days, the dollar is likely to slide further.

Overall, there is little in the Consumer Price Index numbers that is unexpected, making a November interest rate move no more or less likely.

The behaviour of inflation has caused little concern for the central bank for some time now.

In its most recent forecasts, released in August, the RBA stuck by the outlook it outlined earlier in the year – underlying inflation to hover around 2.25 per cent (in the lower half of its 2 to 3 per cent target band) through to the middle of next year, and gradually rise to around 2.5 per cent thereafter.

It bases its benign outlook on its belief that all the forces acting on prices – some to force them up, some to force them down – collectively cancel each other out.

One of the big positives for households in recent years has been the strength of the currency, which has made imports (particularly clothes, electronics, cars etc) extraordinarily cheap and affordable.

But the dollar’s fall against the US currency in recent months (notwithstanding burst in dollar strength in the last couple of weeks), has seen this boost to household spending power fade.

So, if this was happening in isolation, the effect would be to force prices up.

But softness in the domestic economy, which has seen both economic activity and wages growth slow, means retailers risk quickly losing customers if they push up their prices too fast.

In the RBA’s judgement, the net effect of these opposing forces (a weaker dollar forcing the cost of imports up while a softening labour market and slower wages growth holds back consumer spending) on inflation will be negligible.



Leave a comment

Filed under Uncategorized

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s