Australia | Mar 02 2009
By Andrew Nelson
After months of inflation being a non-issue and with the RBA focused on the looming recession and thinking inflation would take care of itself, the read has now jumped for two months in a row. The TD Securities-Melbourne Institute Monthly Inflation Gauge rose by 0.7% in February, following a 0.8% rise in January.
This is the first time in four months that the annual increase in the Inflation Gauge has exceeded the RBA’s target range. TD Securities Senior Strategist Joshua Williamson notes the increases in the Inflation Gauge in January and February are the fastest back-to-back increases recorded in six and a half-year history of the Gauge. All up, in the twelve months to February, the Inflation Gauge has increased by 3.1%.
Price rises for automotive fuel, meals out and takeaway foods, and audio, visual and computing equipment contributed the most to the overall change in February. Williamson notes the price of fuel was 16% higher in February, but is still approximately 11% below its level of one year ago. The price of rent rose by a little under 1% in February, and is about 13% higher its level of February 2008.
However, these rising price rises were at least partially offset by falls for holiday travel and accommodation, books, newspapers, and magazines, and dairy and related products.
According to Williamson,the extreme volatility in petrol prices has had a significant effect on the monthly change in the TD-MI Inflation Gauge for more than a year now, which means there are several underlying factors of note that mitigate this seemingly alarming increase of inflation. Firstly, he points out that inflation is still lower now than it was during most of 2008, it is just not decelerating as fast as it was. Secondly, he feels there is also a significant pass-through of higher prices from the recent AUD fall.
Add these together and it not surprising that Williamson is in-line with the RBA’s belief of the last 6 months or so, which is that the recession will eventually spill over to lower inflation. However, he admits that the process of locking in a comfortably low inflation rate may take longer than initially expected.
Professor Don Harding, co-creator of the Inflation Gauge, predicts that, based on the Inflation Gauge to February, the ABS March quarter CPI will rise by 1.16%, yielding an annual rate of inflation of 3.6%. He confirms that price pressures strengthened in February, with prices rising in 40 expenditure groups and falling in 12 for a net balance of 28 rises. In short, sustained price pressure continues unabated.
TD Securities Global Strategist and the other co-creator of the Inflation Gauge, Stephen Koukoulas, points out that the strong back-to-back increases in the Inflation Gauge and the breadth of price increases is very concerning given the recession and evidence of sharper falls in inflation throughout the rest of the world. He thinks the RBA board will be a little uncomfortable with these results and as such will consider the range of other ‘less-bad’ indicators in recent weeks.
As a result, he thinks the RBA may well consider pausing its rate cutting cycle as it waits in hope for the fiscal and monetary stimulus that’s already on the table to work its way through the economy. But this should be a short-term consideration only, as he notes the beleaguered global economic climate will at some stage mean the RBA will have to begin cutting interest rates once again.
That’s the best case scenario from the trio, the worst case is that we may only be a few months away from seeing stagflation clearly evident in the Australian economy. Professor Harding theorises that if stagflation emerges, it will reflect an incapacity of policy and opinion makers to learn the lessons of the past.
“The lesson from the 1970s relates to the limitations to stimulatory macroeconomic policy. The more recent lesson is the danger of ‘group think’. Previously this took the form of ‘the boom that will never end’. Now it takes the form of ‘just do something to stimulate the economy, don’t worry about the capacity of the economy to respond or the potential for inflation’,” Professor Harding concluded.