Sunday, 4 December 2011

Inflation keeps falling - a negative CPI for the December quarter?

The economic indicator that I co-created almost a decade ago in concert with Professor Don Harding and Dr Lei Lei Song, the TD-MI Monthly Inflation Gauge, confirms a marked deceleration in the rate of inflation since the early part of 2011.

It is suggesting the official CPI for the December quarter will be negative.

The TD-MI Inflation Gauge was released this morning and it shows a fall of 0.1% in November following a rise of 0.1% in each of October and September. Monthly average rises of 0.2% are consistent with inflation running at 2.5% - the middle of the RBA target band. Monthly averages of 0.1% or less obviously show inflation below the bottom of the RBA target band which is where we are heading at the moment.

With more than five-sixths of the December quarter data available in the results of the Inflation Gauge, it now looks likely that the official CPI (due for release on 25 January) will be negative – perhaps down 0.2% - to confirm a massive disinflation pressure coming from the softer economic performance through 2011 driven by tight monetary and fiscal policies.

Of course, the more important and relevant underlying inflation rate, which will strip out some of the price falls registered for fruit and vegetables for example, will be higher. On current information, underlying inflation rate looks like coming in around 0.3% or 0.4%, which would follow on the very low 0.3% result recorded for the September quarter. As you can see, the annualized underlying inflation rate over the second half of 2011 will be around 1.5% - below the bottom of the RBA target band.

The inflation momentum suggests the risks are building that the RBA will miss its inflation target – on the down side – during the course of 2012. Aggressive interest rate cuts remain on the cards.

Also, the net balance of price changes – a sort of inflation pulse indicator – shows that for the past six months, there is only a small net positive meaning that there are almost as many items with flat or falling prices as there are items with prices rising. This inflation pulse points to low ongoing inflation pressures as 2011 draws to an end.

Having said all of that, the Inflation Gauge is not and was not designed to estimate the quarterly CPI. Its structure is different, compellation of data is different, geographic coverage of prices is different and of course, some price items are difficult to estimate without access to government data (pharmaceuticals for example). This means there are some risks in looking too closely at the monthly movements and overlaying them to the quarterly result. There is more accuracy in looking at the year-over-year results which show inflation falling to 2.1% in November.

The Inflation Gauge is designed to pick turning points in inflation; provide timely monthly updates on inflation given the ABS does not produce a monthly CPI; estimate the general pace of inflation relative to the RBA target (above, on track or below) and highlight some price changes well in advance of the ABS releasing the CPI. Over the course of almost a decade where the Inflation Gauge has existed, it has done this stunningly well in “getting” turning points in inflation and broad inflation trends. It is safe to say that with the information released in the Inflation Gauge today, it is clear that inflation continues to slow. Let’s hope the RBA recognize this and cuts interest rates before inflation gets too low.

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