Inflation slows as the RBA holds rates

For the first time since October 2021, the headline rate of inflation is back within the RBA’s 2-3 per cent target band. Importantly, however, this is not the inflation rate as measured by the annual rate of change in the Quarterly Consumer Price Index (CPI), which is the basis for the RBA’s inflation target. As at the June quarter 2024, that rate still stood at an above-target 3.8 per cent, with the next reading due on 30 October. Rather, it is the August 2024 annual rate of increase in the Monthly CPI Indicator. This was still a good result, representing as it did the lowest year-on-year growth in the Monthly CPI Indicator since August 2021. But on its own it won’t be enough to convince the RBA to cut interest rates.

Australia’s central bank explained why this would be the case the day before the ABS published its latest inflation numbers. On Tuesday, and as widely expected, the RBA announced it was leaving the cash rate target unchanged at 4.35 per cent for a seventh consecutive meeting. Afterwards, in the press conference following the announcement, Governor Bullock explained that, regardless of this week’s inflation reading, the RBA still does not think that inflation will be back sustainably within the target band until 2026. In this context, she cited some important weaknesses of the Monthly CPI indicator, highlighting both its volatility and its partial coverage. And she then went on to emphasise that although a combination of the government’s cost-of-living measures and lower fuel prices were indeed likely to deliver a sub-3 per cent headline result this week (as they duly did), in the central bank’s view this would not ‘really be reflective of the underlying inflation pulse’ in the economy, particularly in the services sector, adding that in the RBA’s judgement, overall demand in the economy was still running ahead of supply. In the same press conference, Governor Bullock also once again explicitly ruled out any near-term cut in the policy rate.

As discussed previously, the RBA has been stressing the importance of the discrepancy between headline and underlying inflation rate for a while now, including the role played by temporary Federal and State government energy rebates in driving this difference. We noted then that the August 2024 Statement on Monetary Policy included an extended discussion on headline and underlying inflation which argued that the current divergence between headline and underlying rates would mainly reflect temporary government policy changes. The view from Martin Place is that these ‘will not materially affect underlying inflationary pressures’, although ‘at the margin’ they might influence inflation expectations.

That’s not to say there is no comfort to be drawn from this week’s inflation numbers. It’s worth noting that in August both monthly measures of underlying inflation fell to their lowest rates for 2.5 years. The annual rate of increase in the CPI, excluding volatile items and holiday travel, dropped to 3 per cent last month. And annual growth in the Annual Trimmed Mean measure – which excluded the impact of the falls in electricity and fuel prices – eased to 3.4 per cent, down from 3.8 per cent in July and 4.1 per cent in June. Those results confirm that Australia’s disinflation process continues to play out and suggest that the apparent ‘stall’ in disinflation earlier this year was only a temporary setback.

Despite the RBA’s caution on timing, interest rates will be coming down.

There are more details on inflation numbers and this week’s RBA meeting below, along with a roundup of the rest of the week’s economic data and a selection of links, which include the new RBA Financial Stability Review and the latest OECD economic forecasts. We also cover inflation and the RBA in this week’s Dismal Science podcast, along with a discussion of Beijing’s latest efforts to jump start the faltering Chinese economy.

Finally, my regular reminder that my next economics webinar will tackle Australia and the New Economics of Industrial Policy. The live session will be held on Thursday 17 October from 12 to 1pm. You can register here.

Monthly Consumer Price Index (CPI) Indicator up 2.7 per cent

The ABS said the Monthly CPI indicator rose 2.7 per cent over the year to August 2024, down from a 3.5 per cent increase in July and a 3.8 per cent rise in June. The August 2024 reading is the lowest increase since August 2021 and marks the first time that the headline monthly rate has been back in the target band since October 2021.

The drop in the headline annual rate to below three per cent was expected by market economists – the 2.7 per cent print was in line with the median market forecast – and by the RBA, which had flagged the likelihood at yesterday’s press conference (see next story).

A big driver of the overall decline in the monthly CPI indicator was a 14.6 per cent monthly drop in electricity prices, following a 6.4 per cent decline in July 2024. That August monthly decline translated into a dramatic 17.9 per cent year-on-year slump in the price of electricity, which marked the largest annual fall on record. That in turn was the product of the combined impact of Commonwealth Energy Bill Relief Fund (EBRF, comprising $300 in four $75 quarterly instalments except in Western Australia, where it will be two $150 instalments) rebates in all States and Territories, plus State rebates in Queensland ($1,000 one-off rebate), Western Australia ($400 in two $200 instalments) and Tasmania ($250 one-off rebate). Excluding the rebates, electricity prices would have risen 0.9 per cent in July and 0.1 per cent in August.

As noted at the time, electricity prices had already fallen in July, as households in Queensland and Western Australia received their first instalment of the EBRF one month before those in the other States and Territories. State government rebates in Queensland, Western Australia and Tasmania were also paid out in July.

According to the Bureau, since EBRF rebates were first introduced in July 2023 (and then later extended and expanded to all households in July 2024), the cumulative impact has been substantial: absent these rebates, electricity costs for households would have increased by 16.6 per cent since June 2023.

The slowdown in inflation in August this year also reflected lower fuel prices: automotive fuel prices were 7.6 per cent lower than in August 2023, after having risen by 4 per cent over the year in July. The average monthly price of unleaded petrol in August 2024 was $1.85 per litre, down from $2 per litre in August 2023. And the pace of increase in food and non-alcoholic beverages also eased, slowing from 3.8 per cent over the year in July to 3.4 per cent in August.

In some other parts of the economy, however, inflationary pressures remained significant. Rental price inflation was 6.8 per cent over the year to August, down only marginally from July’s 6.9 per cent increase. New dwelling prices were up 5.1 per cent, with the annual rate of increase having been sticky at around 5 per cent since August last year. And insurance prices jumped 14 per cent over the year, unchanged from their July rate of increase, as higher reinsurance, natural disaster and claims costs continue to push up premiums.

More generally, services inflation (4.2 per cent) continues to outpace goods inflation (1.4 per cent) and inflation in non-tradables (3.8 per cent) remains higher than tradables inflation (0.5 per cent).

Still, while it is true that the main disinflationary impulse this month came from falls in electricity prices due to temporary government support and falls in typically volatile energy prices, there was still a broader disinflationary story in play. So for example, the annual rate of increase in the CPI, excluding volatile items and holiday travel slowed to 3 per cent last month, down from 3.7 per cent in July and 4 per cent in June. Likewise, annual growth in the Annual Trimmed Mean measure – which excluded the impact of falls in electricity and in fuel prices – eased to 3.4 per cent over the 12 months to August after having risen by 3.8 per cent in July and 4.1 per cent in June. Moreover, both measures of underlying inflation have now fallen to their lowest rates for two and a half years.

RBA keeps cash rate target unchanged at 4.35 per cent

The 23 -24 September meeting of the RBA Board ended as widely expected, with the cash rate target left unchanged at 4.35 per cent for a seventh consecutive meeting. Indeed, over the course of the 12 meetings beginning in July 2023, there has now been only one change – a single 25bp hike at the November 2023 meeting.

Despite last week’s decision by the US Fed to confirm a turn in the global rate cycle with an outsized 50bp rate cut, Australia’s central bank continues to sound cautious about prospects for any reduction in the domestic policy rate from its current 12-year high. The accompanying statement reminds readers that although inflation has fallen from its 2022 peak, it nevertheless remains above target and is proving persistent. The RBA does concede that headline inflation is likely to fall further after easing to an annual rate of 3.5 per cent in July 2024, according to the Monthly CPI Indicator. However, it cautions that this is due to the temporary effects of federal and state cost of living relief. In contrast, the central bank does not expect underlying inflation, which the Board sees as more indicative of inflation momentum, to return sustainably to target until 2026. (Underlying inflation has already been above the midpoint of the target band for 11 consecutive quarters.) That means:

‘Policy will need to be sufficiently restrictive until the Board is confident that inflation is moving sustainably towards the target range.’

To that end, the RBA remains in data-dependent mode:

‘The Board will continue to rely upon the data and the evolving assessment of risks to guide its decisions.’

In her press conference following this week’s meeting, Governor Bullock elaborated on some of this. In particular, she stressed the importance of looking beyond the headline inflation rate to consider underlying inflation, when it comes to the RBA’s declared aim of having inflation ‘moving sustainably towards the target range’ [emphasis added]. This was the day before publication of the August 2024 monthly CPI indicator and in this context the Governor said while she would not be surprised if the headline reading fell below 3 per cent (as it did, see previous story), this result would need to be set against (1) the general volatility of the monthly series, (2) the partial nature of its coverage and in particular (3) the temporary effects of cost-of-living relief measures on the headline rate,. She stated that in the RBA’s view, a sub-3 per cent headline rate was not reflective of the underlying inflationary pulse in the economy.

There were several other points of note from the press conference:

• Responding to a question on the outlook for rates, the Governor stressed that the RBA Board does not (currently) see any near-term prospect for a cut in the cash rate target.

• On the other hand, she also noted that the Board did not explicitly consider the case for a rate hike at this meeting, marking a change from recent meetings. The Governor explained this in terms of the format of the meeting and the discussion, which she said focused on what had changed since the last meeting (held on 5-6 August). But despite the statement once again emphasising that ‘the Board is not ruling anything in or out,’ the chances of a rate hike from here do look to have faded significantly, with nearly all attention now on when the RBA is likely to cut.

• In that context, the Governor also reminded her audience that Australia did not have to mechanically follow rate moves by other central banks, given the floating Australian dollar. She also highlighted ways in which economic conditions here differ from those in many economies that have started to cut rates: Australia had hiked its policy rate by less; Australian unemployment had risen by less; and Australian inflation had fallen by less.

• Finally, and echoing some of the content in the statement, she commented that the June quarter national accounts confirmed that economic growth had been weak and noted that household consumption had been softer than the RBA had anticipated in its latest forecasts. That was a useful reminder that the future trajectory of household consumption continues to be one key source of uncertainty for the RBA’s projections.

What else happened on the Australian data front this week?

The ABS said there were 329,900 job vacancies in the economy in the quarter to August 2024 (seasonally adjusted). That was down by 5.2 per cent or 18,100 vacancies from the previous quarter and 17.1 per cent lower than in the same period last year. It also represented a ninth consecutive fall in vacancy numbers. Even so, vacancies remain 45.1 per cent or 102,000 vacancies higher than they were in February 2020, prior to the COVID-19 pandemic. In some industries (Arts and recreation services and Accommodation and food services) vacancies were still more than double their pre-pandemic levels. There were 294,100 private sector vacancies in the quarter to August (down 4.9 per cent over the quarter and 16.9 per cent over the year) and 35,800 public sector vacancies (down 7.5 per cent and 18.9 per cent, respectively).

The latest National Accounts: Finance and Wealth release from the ABS reported that household wealth increased for a seventh consecutive quarter, rising by 1.5 per cent ($249.7 billion) to $16.5 trillion in the June quarter 2024. The rise in net wealth was driven by the housing market and a $216 billion rise in the value of residential land and dwellings. The value of household financial assets was also up, rising by $49.5 billion.

The Judo Bank Flash Australia Composite PMI Output Index fell from 51.7 in August this year to 49.8 in September 2024. At an eight-month low, the index dropping below the neutral value of 50 indicates that activity declined slightly in September. That modest contraction reflected the combined impact of a slowdown in services activity (the Flash Australia Services PMI Business Activity Index fell from 52.5 in August to 50.6 in September) and a deeper contraction in manufacturing activity (the Flash Australia Manufacturing PMI Output Index fell from 46 in August to a 52-month low of 44.2 in September). The survey data also reported that average input costs increased at slower rates across both the manufacturing and service sectors this month, which allowed firms to raise selling prices at their softest pace since December 2020. Likewise, firms said increased competition had seen output price inflation ease to its weakest rate since the same year.

The ANZ-Roy Morgan Consumer Confidence Index rose 0.8 points to an index reading of 84.9 for the week ending 22 September 2024. The rise in confidence was driven by an improvement in confidence in the economic outlook, with the ‘short-term economic confidence’ subindex up 2.7 points and the ‘medium-term economic confidence’ subindex up three points. Both subindices are now at their highest levels since the first quarter of this year, while the overall confidence index is now at its highest level since January 2023, although the latter has still not (quite) been able to pierce the 85-mark, which has now served as a barrier for 19 months. By way of comparison, in the 1990s recession, confidence was below 85 for nine months. ANZ reckons the upturn in confidence last week could reflect the resilient labour market conditions confirmed by the August 2024 labour force results, which might have eased household fears about unemployment risk. Meanwhile, the survey measure of ‘weekly inflation expectations’ rose 0.1 percentage point to 4.9 per cent.

The ABS said Engineering Construction Work Done rose 1.2 per cent over the June quarter 2024 (seasonally adjusted), to be up 5.7 per cent over the year. Work done for the private sector rose 0.4 per cent quarter-on-quarter and 1.7 per cent year-on-year, while work done for the public sector was up 2.2 per cent in quarterly terms and 10.9 per cent higher on an annual basis.

Other things to note . . .

• The latest edition of the RBA’s Financial Stability Review says although global inflation has eased, the world economic outlook continues to be uncertain and vulnerabilities in the global financial system remain. The Review highlights three of the latter, which it reckons ‘stand out as having the potential to significantly impact financial stability in Australia’: (1) operational vulnerabilities arising from the increased complexity and interconnectedness of the digital economy; (2) a mix of low levels of risk premia and leveraged positions leading to an increased potential for a disorderly adjustment in global asset prices; and (3) imbalances in China’s financial sector. Closer to home, the Review judges that ‘risks to the Australian financial system from lending to households, businesses and commercial real estate remain contained’. More specifically: (1) the share of business and household borrowers experiencing severe financial stress remains small; (2) most borrowers have ‘generally strong financial positions’ with very few mortgage borrowers in negative equity and most businesses that have entered insolvency being small and having little debt; and (3) overall indicators of financial stress in the Australian commercial real estate market are still low by historical standards. Overall, the Review reckons the ‘Australian financial system continues to display a high level of resilience.’ The Review did warn that if households respond to any easing in financial conditions by taking on excessive debt, this could increase domestic vulnerabilities, especially regarding the residential property sector. There is also a discussion of the financial stability implications of AI.
• Also from the central bank, the September 2024 edition of the RBA chart pack.
• The view from the FT on the political ‘soap opera’ threatening to derail RBA reform.
• The Productivity Commission Inquiry Report on A path to universal early childhood education and care.
• Jeff Borland considers the RBA and Australia’s unemployment rate.
• The Grattan Institute says while there are ‘good reasons to seriously consider the nuclear option’ there are six problems with the Coalition’s nuclear plan.
• The OECD Interim Economic Outlook September 2024 reckons the global economy will expand by 3.2 per cent both this year and in 2025. According to the OECD, world economic growth has remained resilient, with activity led by services. International trade has recovered, with global container traffic having ‘mostly adapted’ to the effective closure of the Red Sea route and lower water levels in the Panama Canal. Although journey times have lengthened, congestion has risen in some Asian ports and container shipping costs have increased. Labour markets have tended to loosen, partly due to moderating demand but also reflecting rising labour supply, often the product of strong immigration flows, with increases in foreign-born workers accounting for the majority of labour force growth since the start of 2023 in Australia, Canada, the United States, and many European economies. Inflation has continued to moderate and is now at or approaching central bank targets in an increasing share of countries, although there are also signs of some underlying pressures, with services price inflation proving particularly sticky and abating only slowly. While the OECD says its projected outlook is ‘relatively benign’ with steady or improving growth and moderating inflation, it also reckons there are significant downside risks due to uncertainties about ongoing geopolitical conflicts, the pace of disinflation and the lingering impact of still-high real interest rates.
• Two FT Big Reads. The first evaluates Trumponomics, which the piece says is promising radical adjustments to US economic policy, including a more aggressive use of tariff policy, a crackdown on immigration and a push for greater political influence over monetary policy and the US dollar. The piece argues that at the core of the policy proposals are ideas that – if implemented – would transform economic policymaking in several areas, including by marking a return to an era where a large share of government revenue came from tariffs rather than income taxes, as well as to a time when central banks were considerably less independent of their political masters. The second piece asks Did central banks get the inflation crisis right? The tone here is cautiously optimistic. On balance, it reckons leading central bankers feel they have given themselves a decent chance of securing a soft landing, even though the level of economic uncertainty remains high.
• Shall we repeal the laws of economics? Why politicians make economic promises they can’t or shouldn’t keep.
• On ‘cheapflation’ and the rise of inflation inequality. The argument here (based on household scanner data from the UK) is that the 2021-23 surge in inflation was characterised in part by faster price increases for goods at the lower end of the quality ladder. Since worse-off households tend to be more exposed to price rises for lower-quality products, the result is inequality in inflation. The main factor behind this trend seems to have been cost increases, along with a role for differences in pass-through.
• The IMF’s Gita Gopinath spoke recently on the case for A strategic pivot in global fiscal policy. She argued that against a backdrop of marked growth in global public sector debt (it reached 93 per cent of world GDP in 2023 and the IMF thinks it will approach 100 per cent by the end of this decade) it is time for fiscal adjustment in order to allow budgetary room for some big structural pressures on government spending: climate mitigation and adaption; the healthcare and pension spending associated with ageing populations; and more defence spending in response to rising geopolitical tensions (which the Fund reckons could amount to 7-8 per cent of world GDP annually on average for the global economy by 2030). Adding to the case for a fiscal response is the shift away from the world of the global savings glut and large-scale central bank purchases of government bonds, which means larger deficits are now more likely to be associated with higher term premia and therefore the risk of adverse debt dynamics.
• Also from the IMF, a new departmental paper analyses how Southeast Asian emerging markets respond to external shocks.
• Meet the ‘Lumbering Leviathan’: The Economist magazine argues rich world governments are bigger than ever, but also more useless.
• This piece on the stagnation of the British economy has received quite a lot of linkage. The main argument is ‘the most important economic fact about modern Britain [is] that it is difficult to build almost anything, anywhere. This prevents investment, increases energy costs, and makes it harder for productive economic clusters to expand. This…lowers…productivity, incomes and tax revenues…Britain’s economy has stagnated…because it has banned the investment in housing, transport and energy that it most vitally needs’.
• Ricardo Caballero argues that, contrary to what is sometimes presented as the new conventional wisdom, the neutral rate of interest (r-star) may prove to be lower than we think. Caballero points to the impact that elevated levels of global debt will have on constraining demand and what he predicts will be a pending upward correction in the risk premium.
• The latest BIS Quarterly Review includes pieces on life insurance and financial stability, geopolitical alignment and global trade and the growing impact of the US dollar on emerging markets’ local currency flows.
• The WSJ looks at how Argentina has scrapped rent controls.
• Everything you wanted to know about World War Three but were afraid to ask.
• The These times podcast examines developments involving Israel, Lebanon and Hezbollah.
• There is now a Marginal Revolution podcast. The first episode looks at 1970s inflation in the United States.