Australia | Apr 22 2009
By Greg Peel
“A period of low capacity utilisation and a weaker labour market was seen as increasing the likelihood of a decline in inflation over the medium term. As such, members saw scope for a modest reduction in the cash rate.”
So said the RBA in the minutes of its April rate decision meeting, before cutting the cash rate by 25 basis points to 3.00%. From the moment the RBA began its recent rate-cutting cycle, the board was always confident that the economic downturn – the impetus for the cuts – would be accompanied by a gradual fall in inflation back towards the RBA’s “comfort zone” of 2-3%. The fall would not be immediate, given the overhang of contracted annual iron ore and coal prices elevating the terms of trade, and that would need to be watched, but as the RBA suddenly slashed by 100 point increments, rising inflation was no longer a real fear.
And so it is that inflation has indeed been falling, leading the RBA to feel comfortable in making its latest cut despite having held steady. On Monday it was revealed that the producer price index (PPI) – the measure of wholesale inflation – fell 0.4% in the first quarter when economists were expecting a rise of 0.6%. While the PPI is not a clear indicator of what the consumer price index (CPI) result will be, given fluctuations in margins and inventory levels, economists were shocked into thinking they might just have to nudge their CPI expectations down a little.
The headline result dutifully came in at only a 0.1% rise compared to consensus expectation of 0.5%. This takes the annual rate of headline inflation (which includes petrol and food) down to 2.5%. Hence it is already back inside the RBA’s comfort zone, despite having peaked at 5.0% only six months ago. This is great news, as it exactly what the RBA wanted.
The low result was mostly due to the cost of deposit and loan facilities (down 14%), petrol (down 8%) and travel and accommodation (down 5%), offsetting pharmaceuticals (up 13%), rents (up 1.7%), school fees (up 7.6%), veges (6%) and electricity (3.6%), most of which, as ANZ points out, is due to seasonal factors. The was also a slight upward influence from a lower Aussie dollar.
That’s the good news.
The bad news is that while headline inflation may have fallen into the RBA’s comfort zone (eliciting thoughts of another rate cut on the way), the RBA does not use the headline as its measure. The RBA uses the “average trimmed mean and weighted median” (which, apart from anything else, leaves out petrol and food) and that measure showed an increase in the March quarter of 1.1% – much higher than the headline CPI. This leaves the RBA’s underlying inflation measure at a stubborn 4.15% annualised against the peak of 4.8% in the September quarter.
Not much of a difference, and not inside any “comfort zone”.
So realistically this “weak” CPI result is not weak at all. ANZ economist Rick Polygenis has once again raised the spectre of the 1970s and that decade’s accompanying crushing stagflation. Polygenis is not too concerned just yet, and indeed high inflation helps to reduce debt – our biggest problem at present – because debt falls in real terms under inflation and wages rise to assist in repayment.
But if workers refuse to accept pay cuts in the current environment because inflation remains high, businesses looking to cut costs are forced into more lay-offs. The risk is that inflation doesn’t fall, unemployment could rise further than it otherwise might. Yet if wages do fall, that’s bad for household spending. Either way nothing is too good for the economy at present.
And this CPI result realistically means the RBA will not be quick to provide another rate cut in May. Indeed, ANZ now suggests the chances of a May rate cut are “extremely low”. This does not, however, change ANZ’s view that rates could still fall further later in the year.