Tuesday, 24 January 2012

Inflation is a Dead Duck

The CPI recorded zero change in the December quarter locking in a marked deceleration in inflation through the course of 2011.  In the last six months, headline inflation has run at an annualized pace of 1.3%, with some of the deceleration due to a reversal of the price spikes for goods and services impacted by the floods and cyclones early in 2011.

The RBA measures of underlying inflation (which strip away some of the price impact from adverse weather) rose 0.6% in the December quarter after rising 0.4% in the September quarter to be 2.6% above the level of a year earlier.  This continues the run of inflation results at the mid-point of the RBA target.  The RBA has delivered underlying inflation at 2 ½% for the last 18 months.

Well done team!

But in the last two quarters, the underlying inflation rate has increased at an annual pace of just 1.9% - below the bottom of the RBA target and the lowest six month reading (as far as I can calculate with available spreadsheets) since 1998 and is equal to the second lowest six month result since the early 1980s (which is as far back as the history of the underlying inflation measure goes).  I am checking this and will amend if revisions have changed this calculation.

On this measure, inflation is a dead duck.

Thankfully interest rate cuts have started with this disinflationary pressure and with this result, more will be delivered.

With the economy muddling along for the last 3 years, with never once in that time GDP growth rising above 3.0%, it should be no surprise that inflation is so low.  There’s growing capacity in the economy.  What’s more, the labour market is shedding jobs, asset prices are falling with houses and stock prices lower; fiscal policy is tight and the global outlook is shaky. 

The inflation results suggest the RBA is all but certain to deliver an interest rate cut at its 7 February Board meeting with the event and data flow between now and then determining whether the current thinking of a 25 basis point cut will need to be super-sized to a 50 point move.

Global economic conditions may tilt discussion towards a 50 point move, as will the bank funding cost pressures starting to hit the banking sector.  The mining boom, the still high terms of trade and business investment explosion suggest the RBA should cut 25 points only.

The local news between now and the RBA Board meeting on house prices, monthly inflation, retail sales and building approvals will all figure in the discussion.  At the moment, the odds favour a 25 point cut, but stay tuned.


  1. Mate what probability are you now at for Feb (having been near-certain)? I think it is tough to call right now, with so many moving parts overseas. If I had to guess, I'd say coin toss...

  2. I think the need to and know it.... agree re offshore events as a big swing. Put it this way, I am now a buyer of Feb IBs at 885; and the Junes at 45: But note TAB is offering $3.20 for no change!

  3. hahaha! i agree that some of the partial labour data is worrying, but i am fine with everything else (eg, consumption, housing, investment). do you have any views on the unemployment benefits data published by DEEWR? the next issue is on 1 Feb, and it seems to be telling a very different story to the ABS LF data. are there any issues with the DEEWR data do you think? the coverage is much, much better than ABS, but then you could argue there may be lags...

  4. 1.9% would appear to be actually equalled by the 6 months to Sept 2010 (trimmed mean 0.4 and 0.5, weighted median 0.5 an 0.5 in Q2 and Q3). 2.6% annual is the equal HIGHEST level since Q2 2010.
    With core now just slightly above the middle of the target range and policy already neutral I still don't see the urgent need for a move to being more accomodative.
    Clearly events in Europe are the big unknown in all this but might the RBA not want to keep their powder dry for now in case things really do go pear-shaped (which at this stage they don't appear to be doing)?

  5. Christopher - you probably already know this, but there are significant differences in coverage between the ABS LF data and DEEWR's Newstart allowance (NSA) numbers. Obviously, some people would appear in both sets of numbers but each set includes people the other doesn't.

    First, the NSA numbers include people the ABS would not count as unemployed. I saw a recent item that said around 19% of NSA recipients were earning. That's a large number most, possibly all, of whom wouldn't be in the ABS figure. The ABS presumably also won't include people who aren't currently looking for work, and there are a reasonable number of those on NSA (quite legitimately).

    Second, the ABS does count people that can't get NSA. For example, anyone who is unemployed and looking for work but who has a partner who is working, is in the ABS count, but very likely to not be entitled to NSA due to partner income. They may also be ineligible due to asset levels or because of the effect of lump sum payments. There are a host of possibilities!

    None of this addresses the lag effects introduce by such things as the various waiting periods, which could also colour the picture.

    These are all things that could result in the NSA numbers telling a "...very different story to the ABS LF data."