Low inflation raises chance of rate cut: CommSec's Savanth Sebastian

Low inflation raises chance of rate cut: CommSec's Savanth Sebastian
Low inflation raises chance of rate cut: CommSec's Savanth Sebastian

GUEST OBSERVER

The Consumer Price Index – the main measure of inflation in Australia – rose by 0.5% in the September quarter, below expectations. In seasonally adjusted terms the CPI rose by 0.5%. The annual rate of inflation held steady at 1.5%.

The Reserve Bank monitors three measures to derive the underlying inflation rate. The trimmed mean rose by 0.3% in the September quarter (2.1% annual); the weighted median rose by 0.3% (2.2% annual) and the CPI less volatile items rose by 0.5% (2.1% annual). Overall, underlying inflation rose by 0.4% in the quarter and by 2.1% over the year.

New home sales ease: New home sales fell by 0.4% in July. Sales of multi-units fell by 4.2% while detached house sales rose by 0.7%.

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Low inflation raises chance of rate cut: CommSec's Savanth Sebastian

What does it all mean?

Inflation remains healthy without being excessive. In fact the economic environment in Australia is far different from some other parts of the globe. The euro zone continues to worry about the deflationary threat from sluggish growth, while in the US inflation remains below the Fed’s target rate. But here in Australia underlying inflation is holding at the low end of the Reserve Bank’s target 2-3%.

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 rose by a less-than-expected 0.7% in the June quarter. Even the underlying measures were on the weaker side, with the annual growth rates at the low end of the Reserve Bank’s 2-3% target band. The average of the three key underlying inflation measures lifted by 0.5% in the quarter to be up 2.2% over the year.

Interestingly the ongoing slide in the Aussie dollar is starting to have an impact on the on lifting imported inflation. The tradeable component of the CPI result rose by 1.2% in the June quarter. The substantial rally in oil prices over the June quarter was the main driver of the result. In fact the 12% surge in the price of petrol marked the largest increase in 25 years and the main contributor to the inflation result. Whichever way you cut it, inflation is not a threat to the economy.

The Reserve Bank can comfortably ignore inflation and discuss merits of another interest rate cut on the economy if needed. But as the Reserve Bank Governor highlighted in his speech today, further rate cuts could be dangerous. It is clear that policymakers will focus more attention on the labour market, shifts in the Aussie dollar and retail activity in coming months. The Governors comments strengthened CommSec view that the Reserve Bank will keep rates on hold over the rest of 2015.

What do the figures show? 

Consumer Price Index

The All Groups Consumer Price Index (CPI) rose by 0.8% in seasonally adjusted terms in the June quarter. In original terms the CPI index rose by 0.7% in the June quarter. The annual rate of inflation rose from 1.3% in the March quarter to 1.5% in the June quarter.

Underlying measures of inflation were marginally higher than forecasts in the March quarter. The trimmed mean measure rose by 0.6% in the quarter, to be up 2.2% over the year. The weighted median measure rose by 0.5% in the quarter with the annual rate at 2.4%. The CPI less volatile items rose by 0.4% in the quarter to be up 2.0% over the year.

The Bureau of Statistics noted: “The most significant price rises this quarter were for are automotive fuel (+12.2%), medical and hospital services (+4.5%) and new dwelling purchase by owner–occupiers (+1.5%). These rises were partially offset by falls, for domestic holiday travel and accommodation (–5.4%) and pharmaceutical products (–1.8%).”

Prices of tradables rose by 1.2% in the June quarter, with higher prices for automotive fuel. The most significant offsetting fall in the tradable goods component was for pharmaceutical products and vegetables. The tradables component fell by 0.3% over the year to June.

Prices of non-tradables rose by 0.5% in the June quarter. Price increases were recorded for new dwelling purchase by owner-occupiers. The most significant offsetting fall was for electricity. The annual rate of non-tradables inflation rose by 2.6% in the year to June. Tradable goods are those items whose prices are largely determined on the world market. Non-tradable prices are more affected by domestic economic conditions.

New home sales

New home sales fell by 0.4% in July. Sales of multi-units fell by 4.2% while detached house sales rose by 0.7%.

The Housing Industry Association reported: “In the month of July 2015 detached house sales increased by 4.2% in New South Wales. Detached house sales fell by 2.3% in Victoria and by 4.9% in Western Australia. Sales were close to flat for the month in Queensland (-0.6%) and South Australia (-0.2%).”

“The annual peak for detached house sales has passed. Over the three months to July this year detached house sales fell by 2.8% to be 3.4% lower when compared to the three months to July 2014.”

“‘Multi-unit’ sales peaked in May this year and fell by 4.2% in July following a decline of 2.9% in June. Over the three months to July this year multi-unit sales increased by 8.3%, but it was the strength of the May result that drove the quarterly outcome.”

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% 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.

 

The Housing Industry Association releases data on the sales of new homes each month. The HIA collects the data each month from a sample of Australia's largest 100 home builders. The survey covers around 14% of the home building industry

What are the implications?

At present inflation is very much under control and not a threat to a movement in interest rates in either direction. We believe the Reserve Bank will be reluctant to cut interest rates again unless a left field event occurs.

 

Savanth Sebastian is an economist for CommSec

Tags: 
Interest Rates

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