Originally published by AMP Capital
- The Australian December quarter Consumer Price Index showed headline inflation of 0.5% quarter on quarter or 1.8% year on year. This was slightly higher than market expectations of a 0.4% rise over the quarter but the annual inflation rate has declined again, from 1.9% in the September quarter.
- Underlying inflation, as measured by the trimmed mean and weighted median, averaged 0.4% over the quarter and 1.8% over the year which was in line with market expectations and the September quarter. The RBA uses underlying inflation as the best guide to fundamental price trends in the economy because it excludes volatile price changes.
- Both the headline and underlying rates of inflation are continuing to track below the RBA’s 2-3% target band (see chart below), which argues for the RBA to re-think its communication about the next move in interest rates being up.
In the December quarter, there were decent price rises for tobacco (due to the Federal Government’s excise tax), domestic holiday travel (reflecting the usual seasonal impact from school holidays) and food including fresh fruit and meat (which are being impacted by the drought). These were partly offset by price falls for fuel (because of lower oil prices), clothing and footwear prices (as businesses continue to discount stock), communications, audio and computing goods, health costs (from the seasonal impacts of PBS changes) and (in good news for consumers) – wine. The overall sense from the price data was of continuing underlying price weakness.
Besides the mean and median measures of underlying price inflation, other measures of underlying inflation remain very low. Inflation excluding food and energy, which is the US core measure of inflation, is running at just 1.7% year on year. Inflation in the private sector of the economy excluding volatile items is running at 1.5% over the year (as measured by the “market goods and services ex volatile items” index). In contrast, inflation in the government-influenced areas is much higher with education up 2.7% year on year, urban transport fares +2.5%, health +3.3%, gas +3.2% and tobacco costs up by +15%.
Implications
Underlying pricing pressures in Australia have been weak over recent years and the December quarter inflation data confirms that this remains the case. While Australian GDP growth was decent in 2018, it was not enough to work through spare capacity in the economy. We expect slower growth in 2019 – now likely to be around 2-2.5% - which means that spare capacity pressures will continue to put downward pressure on prices (and wages). Combined with the run of poor national data lately including a drop in business conditions, lower consumer sentiment, falling manufacturing PMI’s, falling building approvals and falling home prices we think the Reserve Bank will need to downgrade its optimistic growth forecasts (of around 3.25% for 2019) before cutting the cash rate in the second half of the year. We see the cash rate ending 2019 at 1%.