First fall in prices in seven years: CommSec's Savanth Sebastian

First fall in prices in seven years: CommSec's Savanth Sebastian
First fall in prices in seven years: CommSec's Savanth Sebastian

GUEST OBSERVER

Inflation is pretty much non-existent. In fact in the March quarter the Australian economy essentially went through a period of deflation.

The economic environment in Australia is still far different from other parts of the globe, but when it comes to inflation central banks across that globe are facing the same concerns. The euro zone continues to worry about the deflationary threat from sluggish growth and sliding oil prices, while inflation remains below the Fed’s target rate in the US. And here in Australia inflation is holding below the Reserve Bank’s target 2-3 percent.

It is pretty clear that inflation is not a threat to the domestic economy, meaning that the Reserve Bank can comfortably keep interest rates at exceptionally low levels over the medium term. Domestic inflationary pressures remain well contained and given the slow growth in wages it is unlikely to result in a change to the domestic inflation landscape.

The headline inflation measure fell by 0.2 percent in the March quarter, and even more importantly some of the underlying measures were decidedly soft. The annual growth rates remain below the low end of the Reserve Bank’s 2-3 percent target band. The average of the three key underlying inflation measures lifted by 0.2 per cent in the quarter to be up 1.6 per cent over the year.

Looking across the contributors to inflation, the seasonal increases in education fees and medical services were amongst the key factors driving inflation higher. While the fuel price recorded a 10 per cent decline in the March quarter. Whichever way you cut it, inflation is not a threat to the economy. Interestingly the stronger Aussie dollar over the March quarter, seems to have had a significant impact on curtailing imported inflation. The tradeable component of the CPI result fell by 1.4 per cent in the March quarter.

While we don’t think there is a screaming need for interest rates to be cut on economic activity grounds, the low inflation result opens the door for the Reserve Bank to cut rates if they deem it is necessary. The question is whether the Reserve Bank believes that cutting interest rates will actually provide a boost to the economy given that interest rates are already at generational lows.

Interestingly if the Reserve Bank did not cut rates next week, the market could take that as a sign that it would take a drastic downturn in the domestic economy to cut rates and as such it would provide more impetus for the Australian dollar – an undesirable result. The bottom line is that underlying inflation is undershooting the 2-3 per cent target band and that suggests little risk in cutting rates a little further. CommSec believes there is a strong chance the Reserve Bank will cut the cash rate to a historical low of 1.75 per cent in May.

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First fall in prices in seven years: CommSec's Savanth Sebastian

What do the figures show?

CPI

The All Groups Consumer Price Index (CPI) fell by 0.2 per cent in the March quarter, well below expectations. In seasonally adjusted terms the CPI fell by 0.1 per cent. The annual rate of inflation fell from 1.7 per cent to 1.3 per cent.

Underlying measures of inflation were lower than forecasts in the March quarter. The trimmed mean rose by 0.2 per cent in the March quarter (1.7 per cent annual); the weighted median rose by 0.1 per cent (1.4 per cent annual) and the CPI less volatile items rose by 0.2 per cent (0.6 per cent annual). Overall, underlying inflation rose by 0.2 per cent in the quarter and by 1.6 per cent over the year (equal lowest growth in 33 years of records).

The Bureau of Statistics noted: The most significant price falls this quarter are automotive fuel (-10.0%), fruit (-11.1%) and international holiday travel and accommodation (-2.0%). The most significant offsetting price rises this quarter are secondary education (+4.6%), medical and hospital services (+1.6%) and pharmaceutical products (+4.8%).”

Prices of tradables fell by 1.4 per cent in the March quarter, driven by lower prices for automotive fuel. The most significant offsetting rise in the tradable goods component was for pharmaceutical products. The tradables component rose by 0.8 per cent over the year to March.

Prices of non-tradables rose by 0.4 per cent in the March quarter. Price increases were recorded for secondary education, gas and other household fuels, and beer. The most significant offsetting fall was for electricity and domestic holiday travel and accommodation. Non-tradables prices rose by 1.7 per cent in the year to March. Tradable goods are those items whose prices are largely determined on the world market. Non-tradable prices are more affected by domestic economic conditions.

Why is the data important?

The Consumer Price Index (CPI) is regarded as Australia’s premier measure of inflation. The CPI is published quarterly and measures price changes for a ‘basket’ of goods and services that dominate expenditure of metropolitan households. The “All Groups” index is the main focus, but other inflation measures are also published such as so-called ‘underlying’ measures. These include measures that abstract from price changes in volatile price items such as fresh food and petrol.

The Reserve Bank aims to keep the headline inflation rate between 2-3 per cent over an economic cycle. If inflation is high and expected to rise, the Reserve Bank may elect to raise interest rates in order to constrain price pressures. Conversely, if inflation is low and expected to remain low, the Reserve Bank may elect to cut interest rates if it believes the growth pace of the economy is in need of strengthening.

What are the implications?

At present the national economy is tracking ok. Economic growth is healthy and more encouragingly unemployment is at a 2½-year low. However the concern for policymakers is that the deflationary environment becomes more firmly entrenched in coming quarters. A sustained super low inflation landscape will lead to low inflationary expectations over time and in turn a shift in asset allocation.

It seems there is a broader thematic playing out. The technology disruption and the ability to be able to buy goods whenever and wherever you want is adding to the already challenging environment for domestic businesses. Essentially making it hard to lift prices. The key for business in a low inflation environment is to lift productivity. 

CommSec believes there is a credible risk that the Reserve Bank cuts interest rates to 1.75 per cent next week.

The focus now shifts to the Federal Reserve (FOMC) meeting and rates decision (due out tomorrow morning) and the likely impact on the Australian dollar – particularly given the Fed has been more cautious in recent rhetoric d on the outlook for interest rate hikes.

Savanth Sebastian is an economist for CommSec

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Inflation

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