24 Oct INFLATION SENSATION

Now for a little good news… Inflationary pressures not enough to change RBA policy direction

This article assesses the latest Consumer Price Index data released by the Australian Bureau of Statistics. Inflationary pressures spiked seasonally somewhat in certain areas over the last quarter but overall price pressures remained weak. With future growth headwinds forecast to be strong and inflation risks still benign, interest rates will drop lower in 2014 as the RBA remains focussed on growth.  Where are price pressures showing up and how does this shape the future path of Government policy and Business activity?

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Data highlights

The overall Consumer Price Index rose on a seasonally adjusted basis by 1% in the third quarter to stand 2.3% higher than a year earlier. Despite coming in slightly ahead of expectations, the rate of inflation remained at the lower end of the RBA’s 2-3% price stability band, leaving open the door to further rate cuts in the year ahead. Inflation is not high on the RBA radar at present and more concerns are still being directed toward weak growth conditions, the high dollar, global growth concerns and the rapid approaching of the growth dampening mining investment drop-off.

Closer examination of the CPI data shows a mixed performance across consumer price groups. Rising fuel costs and a weaker dollar drove up petrol prices (+7.8% in the quarter), international travel (+6.1%), domestic travel (+3.5%). On the government price related group electricity costs for consumers were up 4.4% in the quarter, property rates and charges surged +7.9% and water and sewerage prices climbed 9.9%. Education, childcare (+8.8%) and health prices roses also jumped seasonally in the quarter.

In contrast inflation in the food, clothing and footwear, household equipment and ICT equipment groups remained subdued, and it was these counterbalancing price forces which kept overall inflation in check.

Analysis

The ramp up in some price areas this quarter is a reminder to the RBA of the inflationary risks ahead of a lower dollar and higher energy prices, working in tandem with governments’ intent on adding further fuel to the inflationary fire. The charts above show how the period from 2008 has seen huge increases in government connected prices that households pay for utilities, houses, education, childcare and health.

Like other developed nations it is only the falls in food, clothing, furniture and ICT prices which have kept the lid on overall inflation, and given Central Banks the leeway to lower interest rates to emergency lows. It is in these sectors than competition is most intense and where businesses have not been able to pass on cost increases to consumers, unlike the other sheltered and lower competitive sectors of the economy.

Implications

Given the focus on boosting non mining growth in the years ahead the RBA will be looking to get a helping hand from the current band of “inflation sinners” to allow them to cut rates further, lower the dollar, boost growth and keep inflationary pressures at bay. This difficult juggling act of growth v inflation is further complicated by the risks to financial stability from intense house price risks.  In a bad case scenario growth could tumble at the same time that price pressures and other risks increase – in that scenario I still expect the RBA to chose the growth path and keep rates low despite rising price risks.

In the mean time for that large cohort of consumers with large mortgages, children in education and running up later utility bills the disproportionate spending squeeze on disposable incomes will continue. This will further dampen demand for goods and services from small businesses. Too much money will continue to be diverted into the housing, utility, health and education sectors, reducing SME’s slice of the demand pie.

With rates set to be low for a longer period though, investment cost conditions are ideal in some areas for longer term planning, and to switch focus to productivity and innovation to build business strength whilst keeping a close eye on demand, costs and cash-flow.