inflation nation

Going up: fruit and veg prices

Today’s inflation figures were genuinely surprising. Consumer prices rose just 0.4 per cent in the December quarter, well below expectations. Even more surprisingly, the Reserve Bank’s measures of underlying inflation were just as tame, up 0.4 per cent (taken as an average of the “weighted median” and the “trimmed mean”). A quick look at the historical time series for these “analytical” measures of inflation, as the Bureau of Statistics calls them, shows quarterly underlying inflation is the slowest it has been since the series began in 2002.

So in the middle of our biggest mining boom since the Gold Rush days, prices have been remarkably well behaved, for now at least. Why? The soaring Aussie dollar has helped, making imports cheaper and enabling retailers to become even more aggressive in their discounting to otherwise reluctant consumers. Reflecting this, the prices of imported consumer items, like clothing, footwear and computers continue to tumble.

On the upside, food prices are on the up and up. Fruit prices jumped 15.5 per cent and vegetable prices 11.4 per cent. It’s reasonable to assume some of this reflects the impact of the floods, which really began in December. Also up are petrol prices, as improved prospects for the global economy sends crude oil prices northward. I expect we’ll be hearing a lot more about that in the coming year.

Before you get too excited about today’s tame inflation number, remember that this is but a glimpse in the rear view mirror. The Reserve is more worried about what is to come. Already we know that supply shortages resulting from the floods will cause short term spikes in food prices.  Longer term, the rebuilding efforts will also put extra pressure on already limited supplies of workers and resources. It’s economics 101: limited supply and increased demand means prices rise.

Today’s figures certainly relieve pressure on a hawkish Reserve Bank to lift interest rates immediately. My guess is it’s enough to hold fire when they meet next Tuesday. But the Reserve has been singing the same tune for a while now: in an economy running at close to capacity, fuelled by a huge income-shock coming from higher commodity export prices, inflation risks abound.

It’s times like this when the pedal really hits the metal for Reserve Bank governors: do they rely on backward looking statistical releases or trust their guts about where the economy is heading? Glenn Stevens strikes me as a man of strong intestinal fortitude.

Interest rates are still likely to rise this year and probably sooner than you think.

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18 Responses to inflation nation

  1. chris joye says:

    Great article

  2. econogirl says:

    Thanks Chris. You’re top of my blogroll, which, admittedly, is sorted alphabetically 🙂

  3. Tom says:

    Hey Jess

    Looking forward to more of your articles.

    Not sure if you were listening to ABC local radio in NSW last night but Daddo had some guy on talking about the housing market (cant recall his name). He was talking about his company creating an index of Australian housing that was not tied to the underlying value, I think he called them futures (I know SFA about finance).

    Anyhow I was just wondering if something like that, as it’s not connected to the real market, can actually *create* wealth – if not where does the money come from?

    Kind of OT sorry – your post just reminded me of it.

  4. Vestan Pance says:

    Is it only me that finds “…an economy running at close to capacity…” is contradictory to the fact that 16.5% of Australians are Unemployed or Underemployed?

    And if inflation is well within the RBA’s target band and falling, are we sure that “inflation risks abound”?

    • econogirl says:

      Hi Vestan,

      You’re right that at any given point in time there is a high proportion of people who are considered “underemployed”. I prefer the ABS’s measure:

      Re inflation, because monetary policy takes some time to work its way through the economy (in the jargon, it operates with a lag) , the Reserve is more concerned about inflation in 18 months to 2 years from now. This involves a fair bit of guess work and not just looking at the past trend in inflation.


      • Vestan Pance says:

        Hi Jess,

        Could you give some insight as to why you prefer the ABS measure? Roy Morgan reckon their’s is more accurate (as I suppose they would…).

        Re. the RBA, doesn’t this imply that monetary policy is too broad a brush to use in all situations? Fiscal policy could be much more targetted, and would stop situations such as the RBA hiking interest rates even as the GFC struck (which they didn’t see coming, even though they were supposedly looking to the future).

  5. Tanmedia says:

    Hi econogirl,
    I look forward to reading your blog. Given that you’re a voice to the people in your day job, perhaps could you educate us less informed people on some of the limitations of the CPI and the implications for us as economic citizens. For example, I understand that the CPI doesn’t account for housing costs in any meaningful way that it reflects how prices or costs change in the single biggest expense for most people. Secondly, it’s unclear whether or not the composition of the CPI is uniform across different countries. Surely, this has implications for us given that we are interconnected financially or economically. These are just my interests and I have never seen a satisfactory explanation in our media or in the blogosphere. Perhaps I haven’t been looking hard enough. Perhaps the answers are just too damn obvious.

  6. econogirl says:

    Hi Tanmedia,
    Every five or so years, the ABS does a household survey to find out how much the average (or median, can’t remember just now) family spends each year. The Bureau then tracks price movements for those spending items, and gives them different weights depending on how much they represent out of the total household shopping basket. It includes all sorts of things like electricity, gas, vetinary bills etc. But you’re right, it doesn’t include mortgage payments. That’s because the Reserve Bank wants to use it as a way to decide whether it needs to lift interest rates to control demand in the economy and hence cool inflationary pressure (and the other way around if it needs to stimulate demand to stimulate the economy). The CPI has to exclude housing costs otherwise previous Reserve decisions to increase mortgage payments would be picked up, suggesting the need for further rate hikes. See the feedback loop there?
    The CPI is not intended to be a measure of how much each family’s costs have risen – of course we’re all different. Interestingly, the UK Burea of Stats has a “personal inflation calculator” that lets you input your own personal spending to see how your own CPI has moved… But you’re right, every country would have a different CPI, because they’d presumably spend differently and because prices move differently in every economy (although can be influenced by some global factors, like crude oil prices for petrol). Hope that helps!

    • Tanmedia says:

      Thanks econogirl,
      That makes sense but it raises more questions than it answers.
      1.) Doesn’t the RBA’s policy affect all prices, including housing? So the feedback loop would influence all prices including housing. Why wouldn’t mortgage costs, debt servicing, and rent be considered part of a household shopping basket? Am I missing something here.
      I don’t know about you, but I can’t understand why the single biggest expense is ignored when it is the single biggest expense in a household (typically).

      2.) Secondly, if the CPI is used as an indicator for the RBA to control demand in the economy, surely that demand applies to housing costs considering that housing encompasses a large part of economic activity.

      I guess that if accommodation costs (for lack of a better term) would simply change the number.

  7. Sean says:

    Great blog, econogirl.

    I know there are a few overseas fund managers and hedgies out there who are starting to bet that inflation (and consequently interest rates) are both going up. However, considering that the RBA has been more aggressive with their rate rises than their international companions, there is the risk that higher rates will result in higher default rates especially with those on variable rate mortgages. It seems that the “calculus of risk” is beginning to shift in an undesirable way.

  8. senexx says:

    He strikes me as an impetuous RBA Governor

    There is no inflationary outbreak evident – the economy is slowing

    McKibbin normally strikes me that way but since he’s seeking reappointment he is now behaving how I imagine he should have behaved in the first place (the opposite to his usual).

  9. Labor Outsider says:

    Tanmedia. Housing costs (actual and imputed rent) are included in the CPI. Principal mortgage payments are not included because they are not actually a component of household expenditure, but are actually part of household saving (principal repayments imply the accumulation of equity in an asset). Mortgage interest expenses are excluded for the reasons econogirl mentioned.

  10. Dank Castle says:

    Glen Stevens will have to hike rates later in the year when the commodity boom kickstarts the WA economy, creating a risky 3-speed environment. Inflation will run rampant in many parts of the country while others go backwards. It’s the RBAs first major challenge since the GFC ended, an almost impossible situation for them to balance. The eastern seaboard will be hammered, just collateral damage in Glen’s battle against the evil mining boom and the inflation it causes. As employment ramps up at a rapd rate, the RBA must hike rates equally fast, and in the process they will hammer the ponzi real estate bubble for once and for all! I can’t wait!

    Cheers, Dank.

    The Aussie Real Estate Bubble Blogsite

  11. I was wondering if you ever thought of changing the structure of your blog? Its very well written; I love what youve got to say. But maybe you could a little more in the way of content so people could connect with it better. Youve got an awful lot of text for only having 1 or two pictures. Maybe you could space it out better?

    • econogirl says:

      Hey thanks for the suggestion. It motivated me to figure out how to insert breaks so that the homepage only displays summaries, not the whole text. Pretty new at this, so any other handy suggestions welcome!

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