Originally published by AMP Capital
Australian consumer price inflation has fallen short of expectations again, with headline consumer prices up by just 0.2% in the second quarter of 2017 (the market was expecting a 0.4% rise). This saw the annual inflation rate fall back to 1.9% (from 2.1% in the March quarter).
There were some of the usual rises in prices because of June quarter seasonal influences (a rise in health prices due to the annual increase in premiums and a rise in household goods prices after the Christmas sales) along with higher tobacco and beer prices and a solid rise in new dwelling costs. But these price rises were partly offset by a fall in petrol prices, a drop in fruit prices and only a small rise in vegetable prices (despite Cyclone Debbie) and a decline in insurance costs because of the NSW Government’s change to the Emergency Services Levy and there is ongoing evidence of weak pricing power generally with clothing prices down 1.9% year on year, rents up just 0.6% yoy, household equipment flat year on year, car prices down 1.3% yoy and holiday costs down 0.6% yoy.
Of course the headline inflation rate bounces around a bit and so underlying inflation gives a much better guide to the trend because it takes out volatile items and it is also the number the Reserve Bank focusses on. And it remains soft. Underlying inflation as measured by an average of the “trimmed mean” and “weighted median” statistical series was up by 0.5% in the June quarter which was the same as market expectations and annual growth remains unchanged at 1.8%. Underlying price growth has been below the RBA’s 2-3% target band since 2014, which is one of the reasons the cash rate has been cut to a record low.
Another guide to underlying price pressures in the economy is given by an index that the ABS calls “Market goods and services excluding volatile items” and it was up just 0.2% in the June quarter and just 1% year on year, telling us that private sector pricing power in the economy remains very weak. Inflationary pressure is mainly coming from government influenced areas like utilities which are up 4.5% year on year, health which is up 3.8% yoy and education which is up 3.3% yoy.
With the headline rate of inflation and all underlying inflation measures running below the RBA’s 2-3% target it’s hard to see the RBA raising interest rates any time soon.
Implications
The Australian economy is still experiencing below-trend growth and spare capacity in the labour market. This ongoing spare capacity means that price growth for goods and services will remain constrained. Over the near-term, 20% plus electricity price hikes will be a big driver of higher headline inflation but the flow through to underlying prices may not occur for a few quarters and may actually work to push underlying inflation down as discretionary spending power is reduced. And petrol prices still remain constrained and the higher Australian dollar will work to put downward pressure on imported prices. The NAB business survey that tracks prices for purchase costs and final product prices has picked up over recent months (particularly for final product prices) so should be watched for any signs of price pressures. But, the higher prices recorded in the survey could reflect electricity and gas price pressures.
While the broad set of activity data has improved in Australia over the second quarter, there are still reasons to remain cautious on growth (unhappy consumers, slowing housing construction and prices and some further drag from mining investment). We think that below-trend growth and a soft inflation backdrop will keep the Reserve Bank on hold until the end of 2018 or even early 2019, when the improvement in the economy and a rebound in price growth will argue for a start towards the normalisation of interest rates.