- The Q4 CPI numbers were a little lower than analysts expected;
- The risks are that ‘underlying’ inflation may remain under 2% in 2018;
- If that is the case it makes it more likely the cash rate will be unchanged in 2018;
- We get an update on RBA economic views in the first week of February.
I never thought I’d miss you half as much as I do
And I never thought I’d feel this way the way I feel about you
‘It must be Love’ – Labi Siffre
‘It must be love’ was a song originally written by Labi Siffre in 1971, and then covered by Madness in 1981. While both versions of the song did Ok on the charts, it made a wider impact on popular culture. The song was used in a number of advertisements, as well (according to Wikipedia) in a movie (‘Tall Guy’ a movie starring Jeff Goldblum, Rowan Atkinson and Emma Thompson). The theme of the song is based around a love story. But the words quoted above could easily relate to views about inflation. For many years the concern about inflation was that it might move too high, particularly worrying for those with memories of the significant price rises of the 1970s and 80s. But since the GFC the greater concern in many parts of the world is that inflation might stay too low (indeed, Japan has been living that reality for some time).
In Australia, worries about inflation staying too low for too long has not led to the same degree of hand-wringing as in many other parts of the world. But the most recent CPI reading provided a reminder that inflation is below target in Australia. Indeed, both the ‘headline’ and the ‘underlying’ (measures that act to smooth volatile price changes) figures have been below the bottom end of the RBA’s 2-3% band for the past two years.
It does not matter how you slice and dice the latest CPI figures, the answer remains that inflation is too low. Once ‘volatile’ items (such as fruit and vegie prices) are excluded, annual rises in both goods and service prices have been pretty stable at around 1% for the past couple of years. The proportion of all items in the CPI basket that have risen by less than 2% over the past year remains at a very high level. By contrast, the proportion of items rising by over 3% remains low.
As always, the price of some items rise more than others. The biggest price rises in 2017 were in the most important spending categories for many consumers (utilities, petrol, child care, health and education). On the other hand, strong competition and a budget-conscious consumer has meant that household goods have provided the best bargains over the past year (as well as those people that enjoy an egg on toast).
The story the latest CPI data tells is consistent with the view gained from looking at the ‘big picture’. Global inflation is low. And with the $A going up, this makes it hard for Australia to import inflation. Domestically, many firms are not facing cost pressures that might lead them having to increase prices. For most companies their biggest cost is labour. And unit labour costs (wages after adjusting for productivity) have grown by under 1% for the past five years. More generally, firms are reporting that the cost of their inputs in rising well below the typical pace of the past fifteen years.
In any event, most firms would be reluctant to substantially increase prices. Competition is stiff (particularly for retailers). So it no surprise that surveys indicate that firms believe it is tough to get a price rise. All of this fits with consumer expectations that generalised price increases will remain modest. For consumers low inflation is important given that wages growth is currently modest. Real wages growth (wages growth after allowing for inflation) was around 0% in 2017, making it hard for consumers to hit the shops hard. And making things even more difficult is that it is the price of non-discretionary items (such as petrol and electricity bills) are going up the most.
The best forecast is that inflation in the near term is likely to remain low. Any rise of inflation globally in 2018 most probably will be modest. While the Australian labour market is going gangbusters, wages growth may only pickup a little. And strong competition is not going to go away in a hurry. For the RBA, news that inflation is likely to remain low in 2018 won’t be a surprise. The RBA’s most recent forecasts (November 2017) had ‘underlying’ inflation staying under 2% for 2018 (we will get an update on the RBA’s view of the economic world next week with the release of the quarterly Statement on Monetary Policy on Friday 9 February).
Following the release of the CPI, financial markets reduced the odds of a rate hike over the next 3-6 months. If ‘underlying’ inflation remains under 2% in 2018 that would be a reason that would keep the cash rate unchanged in 2018. Other factors to watch include movements in the $A (anything above 80c reduces the chance of a rate move), changes in the unemployment rate (the closer it moves to 5% the higher the chance of a rate change) and the performance of the global economy and financial markets.
It is 16 meetings and counting since the RBA last changed the cash rate. And following the CPI numbers it looks like there will be a few more meetings yet where the cash rate will stay at 1.5%.
We live in interesting times.