There was hysteria in the air today after the Australian Bureau of Statistics released its June quarter figures – Australian Consumer Price Index (27 July 2020). Journalists are skipping their keyboards to see who can come up with the most shocking headlines and narratives. I? I am calm. Given its source, the price pressure will soon dissipate. Inflation fell to 1.7% in the June 2022 quarter from 2.1% in the March quarter. The CPI annualized inflation rate was 6.1%. The most significant contributors during the year are home ownership, food, motor fuel and furniture (the latter mainly due to transportation costs). But looking at the quarterly results alone, we can see that housing is now a negative factor, as the main government programs that fueled the boom are gone and interest rates are higher. There’s little we can do to ease rising fuel costs (besides making public transit free and working from home), while food inflation has dropped to the point where recent massive floods have destroyed crops. That will be a temporary effect. So some of the factors driving inflation are short-term and others will be addressed by factors beyond our control. But with wage pressures absent and the most reliable measure of mid- to long-term inflation now falling, it is difficult to prove that rising inflation is entrenched. There is no reason to be hysterical.
The seasonally adjusted CPI results for the June 2022 quarter are summarized below:
- CPI for all groups rose 1.7% in the quarter (down from 2.1%).
- The CPI for all categories rose 6.1% over the past 12 months.
- The main determinants were owner-occupier purchases of new dwellings (up 5.6%), motor fuel (up 4.2%) and furniture (up 7.0%).
- The trimmed average series grew 1.5% in the quarter and 4.9% over the previous year.
- The weighted median series increased 1.4% for the quarter and 4.2% from the prior year.
ABS media release Note:
Shortages of construction supplies and labor, high freight rates and continued high levels of construction activity continue to drive up prices for new homes. This increase was also contributed by a reduction in grant payments for the federal government’s HomeBuilder program and similar state-based homebuilding programs during the quarter…
Short assessment: Inflation is driven by a relatively narrow set of circumstances related to supply disruptions caused by the global pandemic and timber shortages due to massive bushfires in late 2019/early 2020 Lumber shortages.
The domestic housing boom has also been caused by fiscal measures aimed at homeownership, which have given young first-time buyers an incentive to borrow large sums of money at low interest rates and drive up house prices significantly.
Add to that a dysfunctional tax break for multiple homeownership (negative gearing), and it’s not hard to see why home prices have risen about 20% over the past 12 months.
When designing a fiscal stimulus strategy, it does not make much sense to direct a substantial increase in spending to the private sector/sector that is already facing huge supply constraints due to insufficient inventories.
Much better to build more social housing itself Or direct the stimulus elsewhere.
It is also difficult to see how rising interest rates will alleviate these pressures (see below).
Inflation trend
overall inflation rate 1.7% increase Growth of 6.1% in the June quarter and 12 months of 2022.
The increase is temporary (mainly as transportation resumes and fuel prices for construction materials adjust).
The chart below shows the quarterly inflation rate since the June 2005 quarter.
From a historical perspective, this is a series since the June 1970 quarter. We are nowhere near the inflationary pressures that followed the 1973 OPEC price hike.
The chart below shows the annual headline inflation rate since the first quarter of 2002. The black line is a simple regression trend line that describes the general trend. The shaded area is what the RBA calls the target range (but read below for an explanation).
In this long-term trend inflation rate is down.
What’s driving inflation in Australia?
The following bar chart compares the June 2022 quarter (blue bars) with the March 2022 quarter (green bars) contribution to the quarterly change in CPI.
Note that utilities are a subgroup of housing.
As you’ll see in the graph below, housing was the main driver of annual inflation figures (June 2021 quarter to June 2022 quarter), but it was up in the most recent quarter (March 2022 quarter to June 2022 quarter) quarter) contribution is negative.
That said, housing inflation is now reversing. The boom is over as government programs have largely been withdrawn and interest rates have come into play to curb borrowing. The former is more than the latter.
Gasoline and food drove inflation this quarter.
None of these effects have much to do with the state of the economy – oil prices are driven by cartels, while food prices have risen largely because of this year’s floods that destroyed crops.
ABS states:
Supply chain disruptions caused by flooding events, labor shortages and rising freight rates have led to higher prices.
The graph below shows the contribution (in points) of the various components to the annual inflation rate.
Inflation and Expected Inflation
The chart below shows the four indicators of expected inflation expectations generated by the RBA – Inflation Expectations – G3 – From the June 2005 quarter to the June 2021 quarter.
The four measures are:
1. Market economists’ inflation expectations – a year ahead.
2. Market economists’ inflation expectations – 2 years ahead – so they think inflation will be 2 years from now.
3. Breakeven 10-Year Inflation Rate – The average annual inflation rate implied by the difference between the 10-year nominal bond yield and the 10-year inflation-indexed bond yield. This is a measure of market sentiment towards inflation risks.
4. Inflation expectations of union officials – 2 years ahead.
Not surprisingly, price expectations (as measured by these series) have risen over the past year despite systematic errors in forecasts.
But they hardly ever “go through the roof”.
The most reliable measure – the breakeven 10-year inflation rate – is now falling, down 0.2 percentage points to 2.3 per cent, within the RBA’s target range.
This indicator is a good indicator of long-term inflation expectations.
2-year market economists’ expectations are static. Another sign of the ephemeral nature of this inflation.
This all supports the idea that this doesn’t look like an endemic inflationary event.
Implications for monetary policy
What does this mean for monetary policy?
The RBA uses a range of measures to determine whether they believe there is a persistent threat to inflation.
Please read my blog post – Australian inflation tends to fall – lower oil prices and weaker economy – Discuss in detail the use of headline inflation and other analytical inflation measures.
The Consumer Price Index (CPI) is designed to reflect a broad basket of goods and services (the “Scenario”) that represents the cost of living.You can learn more about the CPI scheme here.
The RBA’s formal inflation targeting rules aim to keep annual inflation (as measured by the consumer price index) between 2% and 3% over the medium term.
The RBA also does not rely on the “headline” inflation rate. Instead, they use two measures of underlying inflation to try to offset the most volatile price movements.
To understand the difference between headline interest rates and other non-volatile inflation measures, you may want to read the June 2010 RBA Bulletin which contains an interesting article – Measures of Potential Inflation. That article explains the different inflation measures the RBA is considering and the logic behind it.
The concept of underlying inflation is an attempt to distinguish trends (“the persistent component of inflation”) from short-term fluctuations in prices. The main sources of short-term “noise” come from “fluctuations in commodity markets and agricultural conditions, policy changes or seasonal or infrequent price reset”.
The RBA uses several different measures of underlying inflation, which are often categorized as “exclusion-based measures” and “trimmed mean measures”.
So you can exclude “a specific set of volatile items – namely fruits, vegetables and motor fuel” to get a better picture of “persistent inflationary pressures in the economy”. The main weakness of this approach is that “the CPI components that are not excluded may experience large temporary fluctuations”, while the volatility components may still trend upwards (eg energy prices) or decline.
Alternative mean trimming measures are popular among central bankers.
The author says:
The trimmed average inflation rate is defined as the average inflation rate after a certain percentage of the price change distribution has been “pruned” at both ends of the distribution. These measures are calculated by ranking the seasonally adjusted price changes of all CPI components in any period from lowest to highest, removing those on the two outer edges of the distribution of price changes for that period, and calculating the average inflation rate Price changes from the remaining set.
So you’re not measuring central tendency by exclusion, but by reducing the weight of volatile elements. The RBA uses two adjusted measures: (a) “15% adjusted mean (excluding 15% of items with the smallest and largest price changes)”; (b) “weighted median (i.e. distributed by price change) price change at the 50th percentile of the weight calculation)”.
So what happened to these different measures?
The chart below shows the three main inflation series released by the ABS since the June 2009 quarter – annual percentage change in CPI for all items (blue line); annual weighted median (green line) and trimmed mean (red line) Variety.
The RBA’s inflation target range is 2% to 3% (shaded area). Data are seasonally adjusted.
All three measures are currently below the RBA’s target range:
1. The CPI inflation measure rose 6.1% (up from 5.1% in the previous quarter).
2. The RBA’s preferred indicators – trimmed average of 4.9% and weighted median of 4.2 – are not currently in the RBA’s target range, but given the direction of house price inflation, the divergence will not last long.
How do we evaluate these results?
1. There has been a lot of talk of a burst of inflation expectations, which has been used to justify rate hikes.
Private bank economists who are constantly being pushed by the media to comment on future rates are apparently talking about rising rates because their organisations benefit, which raises the question of why they are being used in this way and seen as independent authorities.
But the most reliable measure of medium- and long-term inflation is now falling.
2. One of the main drivers of inflation – housing – is now a negative factor.
3. In my opinion (without a vested interest), the inflation trend does not provide a rationale for the RBA to continue raising rates.
4. No wage pressure.
5. Major contributors are declining.
6. There is no major structural tendency for the inflation rate to continue to rise.
in conclusion
Inflation in Australia has risen in line with world trends, but remains below the level in the United States.
The main sources of price increases are temporary – adjustments to pre-pandemic levels, anti-competitive cartel behaviour and the war in Ukraine.
In Australia’s case, shortages of building materials caused by bushfires and higher food prices caused by major floods have complemented these effects.
I am calm.
The right policy response would be to provide financial support to low-income households to help them cope with the current rising cost of living.
Enough for today!
(c) Copyright 2022 William Mitchell. all rights reserved.
