Core inflation nudges higher

Despite the headline (seasonally adjusted) CPI data coming in a good deal lower than expected, the more significant (so far as potential RBA rate decisions is concerned) core inflation measures nudged very slightly higher in the June quarter.

The headline CPI came in as +0.2% q/q for a +1.9% y/y rate. Expectations had been for +0.4% q/q to leave the annual rate about unchanged at +2.1%. However, the more closely-watch core measures (Trimmed Mean and Weighted Median) both came in at +0.5% q/q for an annual increase of 1.8%; a slight increase from the +1.75% rate of the previous quarter and broadly in line with expectations.

Given that the A$ on a trade weighted basis has risen by 4.8% over the past year, it is little surprise that Tradables inflation is a major reason for low price increases. Over the year we see Tradables inflation running at just +0.4% y/y (down from +1.3% y/y last quarter) while Non-tradables hit a new 3 year high of +2.7% in June. If the RBA can actually get their way and drive the A$ lower then we should see the Tradables inflation numbers start to edge higher, and that in turn will no doubt push CPI back up. The ultimate result of that, of course, would be the RBA having to push rates higher which would counter the decline (if there is one) in the A$!

Inflation edges higher…as expected. Tradables inflation at 3 year high.

In line with market expectations, the inflation data released by the ABS today shows CPI back within the RBA’s 2-3% target range.

For the March quarter headline CPI rose by 0.5% for an annual increase of 2.1% (up from 1.5% in the previous quarter). The RBA’s preferred “core” measures of inflation (Trimmed Mean and Weighted Median) were up an average of 1.8% for the year.

Certainly inflationary pressures remain muted and this data will not be forcing the RBA’s hand on rate hikes any time soon. However, it is worth noting that the Tradables inflation measure (basically prices of goods that trade on foreign markets) was up 1.3% which, while still low, is the highest it’s been in 3 years. Non-tradables inflation was at 2.6%.

CPI nudges higher but core inflation falls

The ABS data for inflation in the third quarter shows the headline CPI number edged slightly higher by 0.7% q/q for a year on year increase of 1.3% (up from 1% in June). However, the two core inflation measures preferred by the RBA (trimmed mean and weighted median) were up just 0.4% and 0.3% q/q respectively for an average year on year increase of just 1.5% (down from +1.6% in the previous quarter).

The numbers were broadly in line with market and RBA expectations and are therefore unlikely to provide and further pressure for additional interest rate cuts. As a result the A$ rallied slightly after the release from US$0.765 to US$0.77.


Cost of Living Indexes fall again

After the release last week of the record low headline CPI numbers for Q2 (see here), and the RBA’s subsequent decision to cut rates by 25 bps yesterday, it comes as no surprise to see the quarterly Cost of Living Indexes confirming the lack of any inflationary pressure.

The COL Indexes are designed to answer the question “By how much would after tax money incomes need to change to allow households to purchase the same quantity of consumer goods and services that they purchased in the base period?” They consider this question for a variety of household types (given the different expenditure patterns of households).

Once again we see annual cost of living increases for all household types either down or unchanged from the previous quarter.

Q1 Q2 Q1 Q2
Pensioner & beneficiary 0 0.4 1.1 0.9
Employee 0 0.3 1.1 1.0
Age Pensioner 0 0.5 0.8 0.7
Other Govt Transfer Recipient -0.1 0.5 1.1 1.1
Self-funded retiree -0.4 0.4 1.1 1.1
Headline CPI  -0.2 0.4 1.3 1.0


Gulf opening up between actual and expected inflation

Each month the Melbourne Institute release their Survey of Consumer Inflationary Expectations. This gives a good indicator where people believe inflation is heading. The chart below compares those expectations (on a quarterly basis) with the actual average core inflation data. What we see is that generally people’s expectations are, on average, higher than reality. Over the course of the past 17 years inflationary expectations have averaged 0.4% higher than the actual.

It also highlights that, where actual inflation moves significantly outside of the RBA target band (as happened through late 2007 to mid 2008), expectations tend to overshoot reality. Likewise, when the GFC struck and inflation started to fall quickly expectations again overshoot, this time on the downside.

What the 12 quarter moving average lines tell us is that since early 2014 when actual inflation started to fall away, expectations have remained consistently high. Indeed over the past few quarters we have seen an unprecedented divergence in these two measures opening up. Essentially consumers are saying “I don’t believe that inflation will stay this low for long”. Given the RBA’s success with inflation targeting over the long term (average core inflation over 17 years of 2.78%) we might understand why.

This is a very real example of the idea of rational expectations and a good reason as to why any potential lowering of the RBA’s inflation target should be treated with extreme caution. If the RBA acknowledges that core inflation, over the longer term, has settled into a lower range and they will therefore be targeting that lower range then in all likelihood consumers will start to adjust downwards their own expectations of inflation. This then compounds the very problem the Bank has been facing; trying to actually push inflation somewhat higher. There is a very real danger that we would then enter into a potentially deflationary spiral with lower expectations making further cuts in the Cash Rate less and less effective. Let’s not forget that the RBA’s supply of rate cut ammo is running ever lower as we head closer to zero.

Those advocating for a cut in the target rate might also like to ask themselves, “Would you be calling for an increase in the target if we happened to be experiencing 5% inflation at the moment?”


One for the economics geeks: What’s the last 22 years of unemployment and inflation data in Australia tell us about NAIRU and the Phillips Curve?

Apologies to any others, but if you’re not a dyed in the wool economics tragic read no further.

Back in uni days (over 30 years ago now) the old Phillips Curve theory was still being tossed around (although with modifications from the 1950’s original) and it’s always been something I’ve had niggling at the back of my mind in a very simplified form. My simplified form (in the short term) runs something like this;

If the level of unemployment falls close to, or below, NAIRU (which has generally been thought of as at about 5%, although these days may be lower) doesn’t it make sense that there would be some upward pressure on wage costs and therefore prices?
In addition, isn’t it reasonable to say that those wage pressures would take some time to end up being reflected in actual consumer inflation? (note I’m bypassing the whole idea of rational expectations).

I’ve therefore been a close watcher of unemployment levels and core inflation data with a 12 month lag (an arbitrary lag imposed to allow for that delayed effect on prices). When we plot this relationship for Australian unemployment data from June 1993 to June 2015 (latest data allowing for the 12 month lag in inflation) what we see is below.


A few things appear obvious straightaway:-

  1. The supposed inverse relationship of the classic Phillips Curve is obviously less than robust across all data!
  2. The relationship appears far more robust as we go below about 5.6% unemployment
  3. No matter what kind of trend line you try and fit to the data (and the graph has a number from linear and log to trinomial) the convergence at 5% unemployment and 3% core inflation is obvious.

I’m certainly not trying to suggest that we should be looking at this in any way as a predictor of future inflation; although over the past year unemployment has fallen from 6.1% to 5.8% and would therefore suggest at least the possibility of a move upwards in core inflation over the next 12 months. But it does at least give me some sense that there is a sound reason for the 3% upper inflation target range for the RBA (particularly if we buy into more modern Phillips Curve thinking that would suggest the long term curve is simply the vertical line at NAIRU).

Any other geeks out there got a thought? I’d be interested to hear.

Benign inflation plot confirms room for a rate cut next week

The headline CPI inflation measure for the second quarter has been released in line with market expectations. CPI was up by 0.4% for the quarter and up just 1% over the course of the year (the lowest annual plot since the second quarter of 1999). The average of the two “core” measures, trimmed mean and weighted average, which is the indicator more closely watched by the RBA was up 0.45% for the quarter and +1.5% from a year ago; well below the RBA target range of 2-3%. As a result the door for a possible rate cut at the Bank’s meeting next Tuesday remains well and truly open. However, the core plot was slightly higher for the quarter than had been expected and the market is therefore pricing a 25bps cut as only a 50:50 shot.

Despite communications and transport indexes falling heavily over the year (-7.2% and -2.8% respectively) it was actually the food and housing indexes that were the main drivers of the weak number. These two categories account for almost 40% of consumer spending and therefore have a major impact on the total weighted result. The food index fell 0.1% over the year which is the lowest annual result for over 3 years while housing, on the back of record low interest rates, was up just 1.3% for the year and is the slowest pace of growth since September 1998.

It’s always worth remembering that this inflation data is calculated based on a basket of consumer spending, and the prices of that basket, calculated as a weighted average across the capital cities only and as a result may not be wholly representative of the experience in regional areas. 160727

Cost of Living falls further still

After the release last week of the low CPI numbers, and the RBA’s subsequent decision to cut rates by 25 bps yesterday (see below), it comes as no surprise to see the quarterly Cost of Living Indexes confirming the lack of any inflationary pressure.

The COL Indexes are designed to answer the question “By how much would after tax money incomes need to change to allow households to purchase the same quantity of consumer goods and services that they purchased in the base period?” They consider this question for a variety of household types (given the different expenditure patterns of households). For the March quarter we see that prices fell or remained the same from the previous quarter for all household types with annual changes dropping for most. Indeed all household types saw cost of living increases over the year below even the low Headline CPI print and well below the RBA’s preferred core inflation measure which stood at 1.55% for the year.

Q/Q Yr/Yr
Q4 Q1 Q4 Q1
Pensioner & beneficiary 0.4 0 1.3 1.1
Employee 0.5 0 1.1 1.1
Age Pensioner 0.2 0 1.2 0.8
Other Govt Transfer Recipient 0.6 -0.1 1.4 1.1
Self-funded retiree 0.7 -0.4 1.6 1.1
Headline CPI  0.4 -0.2 1.7 1.3

Yesterday’s reduction in the Cash Rate by 25 bps to a new record low of 1.75% (which came as something of a surprise to us, if not to many others!..see commentary from last week) can be pinned squarely to not just the surprise fall in inflation. As the RBA made clear in its statement following the decision, the changes to regulatory control of lending in the property market was also a major factor allowing the Bank to move without fears of stoking an unwanted burst of property price inflation (as has been a past worry).

“In reaching today’s decision, the Board took careful note of developments in the housing market, where indications are that the effects of supervisory measures are strengthening lending standards and that price pressures have tended to abate. At present, the potential risks of lower interest rates in this area are less than they were a year ago.”

The Bank will be pleased that the fall in the A$ which occurred last week on the back of the CPI data, and the rise in expectation of a rate cut, has been extended further by the cut itself. The A$ is now trading more than 2.5 US cents lower than it was prior to the CPI data last week. As the Bank notes in its statement..

Monetary policy has been accommodative for quite some time. Low interest rates have been supporting demand and the lower exchange rate overall has helped the traded sector. Credit growth to households continues at a moderate pace, while that to businesses has picked up over the past year or so. These factors are all assisting the economy to make the necessary economic adjustments, though an appreciating exchange rate could complicate this.” (my emphasis)

Surprise drop in inflation puts the spotlight back on possible rate cut

Today’s release of first quarter CPI has shocked the market with a reading much weaker than had been expected. Headline CPI fell by 0.2% q/q (against expectations of a 0.2-0.3% rise) for an annual rate of just 1.3% (expected around 1.7%).

The more closely watched Trimmed Mean (+0.2% q/q, +1.7% yr/yr) and Weighted Median (+0.1% q/q and +1.4% yr/yr) were also much weaker than had been expected and take average core inflation to +1.55% yr/yr. This is well below the RBA’s target range of 2-3% and the first time since Q2 2012 that the range had been breached (when average core inflation briefly dipped as low as 1.85%). This is the lowest average core inflation print for at least 17 years.

Areas where prices fell sharply in the last quarter were clothing (-2.6% q/q) and transport (-2.5% q/q). Over the course of the year these sectors have fallen 0.8% and 0.5% respectively while communications is down 6.4% for the year (its 8th consecutive quarter of yr/yr falls).

Inflation falling to such low levels will inevitably return focus to the possibility of further rate cuts from the RBA. Since the release of the CPI data the market has moved pricing for a 25 bps cut at next weeks May RBA meeting from about 12% to almost 50%. Likewise, the currency market has responded sharply taking the A$ down from US$0.775 to about US$ 0.765 in the 30 minutes after the release.

While the inflation print is certainly very low other indicators such as employment and GDP are painting a firmer picture and we would therefore be surprised to see the RBA cut on Tuesday. However, given the reality that the Bank needs to wait another 3 months for its next inflation data, there is certainly a possibility that they may wish to strike early. The recent strength in the A$ would also help them to reach for the rate cut trigger. Today’s A$ weakness, while perhaps easing some of the pressure on the Bank to act on rates, is likely to be reversed if no cut is forthcoming next week.


Cost of Living Indexes show no signs of price pressures


The ABS Cost of Living Indexes for the fourth quarter show price increases running at a slightly higher rate than in the previous quarter.

The COL Indexes are designed to answer the question “By how much would after tax money incomes need to change to allow households to purchase the same quantity of consumer goods and services that they purchased in the base period?” They consider this question for a variety of household types (given the different expenditure patterns of households). What we see in the fourth quarter is annual rates at somewhat higher levels to last quarter with the q/q increases nudging up after very low posts in Q3. The Cost of Living remains well below the RBA targeted Core Inflation measure which stood at 2.0% in the fourth quarter (having fallen from 2.15% in Q3).

Q/Q Yr/Yr
Q3 Q4 Q3 Q4
Pensioner & beneficiary 0.2 0.4 1 1.3
Employee 0.2 0.5 0.7 1.1
Age Pensioner 0.1 0.2 0.9 1.2
Other Govt Transfer Recipient 0.2 0.6 1 1.4
Self-funded retiree 0.5 0.7 1.2 1.6
Headline CPI  0.5 0.4 1.5 1.7