Slowing inflation gives RBA (a bit of) room to pause

Key domestic data released this week were the first quarter consumer price index (CPI) numbers, along with the accompanying March monthly CPI indicator. The results showed an annual rate of headline inflation that had slowed both over the quarter and over the most recent month, but one still well above target, thanks in part to an annual rate of services inflation that has now climbed to its highest rate since 2001.

With Australia’s central bank currently in full ‘data-driven’ mode, the official inflation reading was always going to be a big deal. That was especially the case after the RBA’s decision at its April meeting to pause the current monetary policy tightening cycle. Prior to Wednesday’s data drop, the case for extending that pause at next Tuesday’s RBA meeting had looked to be finely balanced, putting even more focus on this week’s outcome.

Last week’s note argued that given a significant drop in the headline inflation rate which was likely baked in based on the monthly CPI indicator readings we’d already seen for January and February, much would rest on the result for the trimmed mean. A parallel decline here would encourage the RBA to continue its pause for another month, while signs of stubborn underlying inflationary pressures would bolster the case for another 25bp move.

As it turned out, we did not get a particularly strong reading either way. The headline rate of annual inflation did deliver the anticipated fall, dropping from 7.8 per cent in Q4:2022 to 7 per cent in Q1:2023. But that decline was slightly smaller than the one that had been predicted by most economists. Meanwhile, the fall in underlying inflation as measured by the trimmed mean from 6.9 per cent to 6.6 per cent was slightly larger than the consensus forecast. Together with another fall in the rate of increase reported by the monthly indicator, that mix of outcomes is - just - enough to give the RBA room to pause again next week on interest rates. But as with April’s decision, this one looks likely to be another close call. More detail on inflation numbers is set out below.

Tune into the latest economic news and analysis this week on The Dismal Science podcast.

Quarterly inflation rate eases to 7 per cent in Q1:2023

Confirming that Australia’s headline inflation rate peaked in the final quarter of last year, the ABS reported the Consumer Price Index (CPI) rose 1.4 per cent over the quarter in Q1:2023 to stand 7 per cent higher in annual terms. That was actually a slightly stronger result than predicted by the median market forecast, which had anticipated a 1.3 per cent quarterly print and a 6.9 per cent annual rate. Even so, after running at close to double digit rates through 2022 (2.1 per cent in Q1:2022, 1.8 per cent in Q2 and Q3 and 1.9 per cent in Q4), inflationary momentum as measured by the rate of quarter-on-quarter growth in the CPI has eased. This result is the softest reading since the final quarter of 2021. At the same time, the rate of annual increase in the CPI has now fallen below the Q3:2022 (7.3 per cent) and Q4:2022 (7.8 per cent) results.

The RBA’s preferred measure of underlying inflation, the trimmed mean, rose 1.2 per cent over the quarter and 6.6 per cent over the year. This time, both outcomes were below the corresponding consensus forecasts for 1.4 per cent quarterly and 6.7 per cent annual increases, respectively. The actual quarterly increase was the slowest since the end of 2021, running below all four 2022 results (1.5 per cent in Q1, 1.6 per cent in Q2, a peak of 1.9 per cent in Q3 and 1.7 per cent in Q4), while the rate of annual increase was down from the December quarter result of 6.9 per cent, but remained comfortably above the other year-on-year increases reported last year.

Another measure of underlying inflation – the weighted median – recorded a quarterly increase of 1.2 per cent in the March quarter (down from 1.6 per cent in the December quarter) and an annual rise of 5.8 per cent (up from 5.6 per cent).

According to the Bureau, key drivers of the quarter-on-quarter increase in March quarter 2023 CPI included:

• An increase in medical and hospital services (up 4.2 per cent over the quarter). The ABS said prices for medical and hospital services typically rise in the first quarter, as this is when GPs and other health service providers review consultation fees, and when the Medicare Safety Net is reset. The Bureau also noted that some private health insurance premiums increased this January.
• A 9.7 per cent rise for tertiary education. Again, the ABS noted that tertiary education fees are indexed at the start of the year. It also pointed to changes in student contribution bands and fees introduced in 2021 as part of the then-Government’s Jobs-ready Graduates Package. The increase in the education group overall (covering primary and secondary as well as tertiary education) recorded its highest rise in five years, partly due to higher wages growth leading to higher school fees.
• An increase of 14.3 per cent for gas and other household fuels due to price reviews reflecting increases in wholesale gas prices. The 26.2 per cent annual increase in gas prices was the largest on record, while higher electricity prices were also a product of the unwinding of state level rebates in Western Australia, Queensland, and the ACT.
• A 4.7 per cent rise for domestic holiday travel and accommodation reflecting strong demand for holiday travel during the holiday period and the return of major events to some capital cities.

Also of note from the housing sector, the annual rate of price growth for new dwellings continued to slow this quarter, down from a peak of 20.7 per cent in Q3:2022 to 17.8 per cent in Q4:2022 and then to 12.7 per cent in Q1:2023. But at the same time, rental prices recorded their largest annual rise since 2010.

The annual rate of overall goods price inflation eased in the March quarter this year, falling from 9.5 per cent to 7.6 per cent due to discounting on furniture, appliances and clothes and lower automotive fuel prices. In contrast, the rate of services inflation moved strongly in the opposite direction, increasing from 5.5 per cent to 6.1 per cent.

Monthly inflation rate falls to 6.3 per cent in March 2023

The ABS said the monthly CPI indicator rose 6.3 per cent over the 12 months to March 2023. That was below the market consensus forecast for a 6.5 per cent rise. Since peaking in December 2022 at 8.4 per cent, the pace of annual inflation as measured by the monthly indicator has now eased for three consecutive months, dropping from 7.4 per cent in January and 6.8 per cent in February this year.

The monthly CPI indicator, excluding volatile items (fruit and vegetables and automotive fuel) rose by 6.9 per cent year-on-year in March 2023, marking a slight increase from the 6.8 per cent annual rate recorded in February 2023.

The Bureau said the most significant price rises last month were for housing (up 9.5 per cent over the year), food and non-alcoholic beverages (up 8.1 per cent) and furnishings, household equipment and services (up 7.2 per cent).

Implications for RBA and 2 March monetary policy decision

As cited above, last week’s note reckoned that details of this week’s inflation reports were likely to be decisive in determining whether the RBA decided to extend its monetary policy pause for a further month when it meets next Tuesday. Yet, somewhat unhelpfully, this week’s set of numbers did not give us a particularly compelling read: although headline inflation turned out to be slightly stronger than the market had expected, the underlying inflation rate was also bit weaker than the consensus forecast. And neither result looked dramatically out of line with RBA forecasts as set out in the February Statement on Monetary Policy, which are due to be updated next week. (As a reminder, back in February, the RBA expected the rate of headline inflation to slow from 7.8 per cent in the December 2022 quarter to 6.7 per cent in the June 2023 quarter and the underlying rate to ease from 6.9 per cent to 6.2 per cent over the same period.)

In terms of factors likely to influence the RBA’s decision, inflation has fallen, but remains well above target; goods price disinflation continues, but so do inflationary pressures in services, where the rate of price increase is now the fastest seen since 2001; and survey measures such as this month’s PMI (see below). Prior to that, the NAB business survey showed that while input cost pressures remain high, they are also continuing to slow. Further, and as we’ve noted over the past couple of weeks now, other indicators continue to send the same mixed signals that have been arriving for some time, with strong labour market outcomes and healthy business conditions set against very soft household sentiment.

In this context, we reckon extending the policy pause for another month while maintaining the current tightening bias to policy would come the closest to allowing the central bank to have its monetary policy cake and eat it too, and we think this is the more likely option. It is also consistent with market pricing at the time of writing, with financial market participants expecting no change next week. All that said, however, we do have to concede that the preceding discussion would also imply that a 25bp hike next week would not be particularly surprising, either.

What else happened on the Australian data front this week?

Last week, the Judo Bank Flash Australia Composite PMI Output Index rose to 52.2 in April 2023, up from 48.5. That took the index to a 10-month high and indicated that private sector activity was back into expansion mode again after having contracted in March. According to the data provider, the return to growth was driven by an increase in service sector activity, which increased at the fastest pace since June last year. In contrast, manufacturing production fell for a fifth consecutive month (although only marginally). The same survey also showed employment increasing for a 20^th successive month and at the fastest pace since January, with staffing up across both manufacturing and services. Finally, although input costs were again up in April, the rate of increase eased for a fifth consecutive month, slowing to its lowest reading since September 2021. Output price inflation increased in April, however, pushed up by services.

After having fallen by 2.1 points in the week ending 16 April 2023, the ANZ-Roy Morgan Consumer Confidence Index edged up by 0.8 points last week to an index reading of 78. Despite that marginal gain, the confidence index overall remained below 80 for an eighth consecutive week, and all housing cohorts now report confidence levels below 80 for the first time since mid-March this year. According to ANZ, this run represents more weeks of sub-80 confidence readings than over the entire 2020-2022 period, indicating the adverse impact of ongoing inflation and the adjustment to tighter monetary policy.

The ANZ-Roy Morgan survey measure of weekly inflation expectations dropped by 0.3 percentage points to 5.3 per cent.

The ABS said total tax revenue in 2021-22, across all levels of government, rose to 29.6 per cent of GDP. That’s the highest reading in a decade, up from 28.5 per cent in 2020-21 and up from 27 per cent of GDP back in 2012-13. The increase in Commonwealth tax revenue was driven by company tax ($28 billion higher over the year), personal income tax receipts (up $27 billion) and GST (up $2.3 billion). The increase in State and local government tax revenue was powered by an $11.7 billion increase in stamp duties and a $3.6 billion rise in payroll taxes.

The 2020-21 Energy Account for Australia from the ABS.

International trade price indexes for the March quarter of this year.

Other things to note . . .

• ABS insights into government finance statistics. The ABS notes the recovery in the general government net operating balance – an improvement of $110.9 billion between 2020-21 and 2021-22 – was the largest such swing in the history of the Government Financial Statistics time series, powered by a $89.9 billion jump in tax revenue and a $58.1 billion fall in subsidy expenses.
• And new insights from the ABS and RBA into Australia’s rental market. According to this information paper, rent inflation has risen and is now broadly based across new and existing tenants, across property types, and across states. The Bureau finds rent increases have become more common. Over the past year, rents have increased for almost three-quarters of properties, up from around one-quarter every year pre-pandemic. It also finds they have become larger on average and that properties with a change of tenant have experienced larger rent increases than existing tenancies. For example, in February 2023, over 60 per cent of properties with new tenants had rent amounts more than 10 per cent higher than 12 months earlier, compared with only one-quarter of properties with existing tenants having similar rent increases. According to the Bureau, rents paid by new tenants increased by 14 per cent over the year to February 2023, which is nine percentage points higher than the increase in the monthly CPI indicator, which measures all rents.
• Also from the ABS, new statistics on cultural and creative activities.
• The 2023-24 Report to the Australian Government on Economic Inclusion by the Interim Economic Inclusion Advisory Committee. The committee advised Canberra to ‘commit to a substantial increase in the base rates of the JobSeeker Payment and related working age payments’, found that ‘income support should better value unpaid caring work and support those who cannot be in full-time paid employment’ and ‘found the current rate of Commonwealth Rent Assistance to be inadequate’.
• Related, Grattan’s Danielle Wood lists three myths that keep Australians in poverty.
• The Defence Strategic Review 2023. Responses from Sam Roggeveen at the Lowy Institute Interpreter and Stephan Fruehling at ASPI’s The Strategist. Also noted, Hugh White’s critique of Penny Wong on Taiwan.
• Speech from BIS General Manager Agustin Carstens on monetary and fiscal policy as anchors of trust and stability.
• Neil Irwin on the global economy’s slow-motion reset. Irwin argues that many of the forces through the 2010s that kept interest rates and inflation low (abundant labour, globalisation, low rates of public and private investment) have now been flipped. These include the retirement of the Baby Boomer generation, deglobalisation as a consequence of geo-economic fragmentation and large-scale investment into semiconductors, battery manufacturing and solar cells that is triggering ‘the mother of all capex cycles’. As a result, the era of low rates is over and one consequence could be a series of rolling financial crises. The failure of Silicon Valley Bank was just the start.
• Related, a new working paper from the IMF offers A long run perspective on the neutral rate of interest across advanced economies, including Australia. The report finds three distinct phases over the past 150 years: a period with stable to slightly declining neutral rates from the 1870s to the Second World War; an increase after the War up until the 1960s; and a steady decline since the 1960s. For the median advanced economy, the decline since the 1960s peak is 4.5 percentage points, bottoming out at 0.5 per cent in 2019. There are also signs of a clear convergence in rates across countries since the 1980s, consistent with greater capital market integration. Most recently, the decline in the neutral (real) rate of interest was driven by increases in the old age dependency ratio and life expectancy, along with slower rates of growth of population, productivity and trend real GDP growth, with the acceleration in demographic aging from the 1990s the most important factor in recent years.
• Also from the IMF, Unleashing India’s growth potential.
• Takashi Ito describes the Bank of Japan’s remarkable decade. According to Ito, departing Governor Haruhiko Kuroda can claim three big legacies from his decade-long tenure at the Bank of Japan (BoJ). He demonstrated ‘the depth and the width of the unconventional monetary policy toolbox’; he did a good job of explaining the importance of flexible inflation targeting as a monetary policy framework; and his policies ‘contributed substantially to the remarkably strong recovery in economic activity before the COVID crisis.’ While there has been growing criticism of some of those policies – defending the Yield Curve Control (YCC) ceiling has required the BoJ to purchase so many government bonds that it has distorted the bond market to an extent that has arguably undermined some of its price discovery function while creating risks around any YCC exit. The Governor’s relaxed attitude to a falling yen and rising inflation has also disconcerted some observers – Ito sees some light at the end of the YCC tunnel.
• INET piece on Markets and AI.
• The Economist magazine on how AI could change computing, culture and the course of history.
• The chronicle of the revolutions foretold? Branko Milanovic reviews Peter Turchin.