NSW2226 Inflation continues to moderate
Inflation continues to moderate
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Inflation continues to moderate
As has been the case in the United States,
Australia’s inflation rate has continued to pull
back from the recent peak reached after a period
of sharp increase. The Consumer Price Index (CPI)
rose by 0.8% in the 3 months to June, which was
0.6% below the increase recorded in the March
quarter. In annual terms, Australia’s inflation rate
dropped from 7.0% to 6.0%. The recent peak of
7.8% recorded in December 2022 was the highest
annual rate recorded since March 1990.
The June quarter CPI result was impacted by a
lower rate of increase for several categories of
goods, whereas service categories, being more
influenced by wage levels, continued to push
higher. Automotive fuel (down 0.7%) was one key
goods category to show price decline, with the
price of motor vehicles also declining. Both motor
vehicles and automotive fuel had previously
recorded sharp increases due to supply
constraints prevailing as economies reopened
after the COVID-19 crisis. Elsewhere, a 0.7% fall
in telecommunication equipment and services
contributed to the lower rate of CPI growth; as
did pharmaceutical products, which fell 1.0% due
to an increase in the proportion of purchases
qualifying for the Pharmaceutical Benefits
Scheme (PBS).
Partially offsetting the above areas of price
reduction was a higher rate of increase in the
price of some services. Housing rents (up 2.5%)
continued to make a major contribution to
inflation and have now risen by 6.7% over the
past year. Also notable was a 5.3% quarterly
increase in house, contents and motor vehicle
insurance, whilst prices for restaurant meals &
takeaway food rose 1.7% over the quarter.
The chart below shows the actual “headline”
inflation rate along with the “underlying” rate of
inflation. This underlying measure of inflation
removes seasonal factors, outliers, and more
volatile components of the CPI, to measure the
core rate of price increase. The “underlying” rate
has become a more important area of focus for
policy markers over the past 3 years as the COVID
crisis and global energy shortages have created
significant temporary influences on the CPI
calculation. As the chart demonstrates, the
underlying measure of inflation is less volatile
than the “headline” unadjusted CPI measure.
Source: Australian Bureau of Statistics 6401
The chart highlights that the underlying rate of
inflation steadily declined between 2008 and
2020. It has, however, recently increased sharply
and is currently calculated to be 5.7%. This
underlying rate of inflation remains well above
the Reserve Bank’s longer-term average target
range of 2% to 3%.
Australia’s experience with inflation following the
COVID-19 crisis is consistent with that of most
developed economies around the globe. Supply
constraints (due to the lower production in
lockdowns and subsequently the War in Ukraine)
combined with the sharp increase in demand
upon economic reopening (supported by both
expansionary monetary and fiscal policy) saw
goods prices rise sharply. Goods inflation has now
started to subside around the globe; however, it
remains to be seen how quickly inflation can
return to target levels. Much will depend on the
persistence of services inflation and the extent to
which higher wages growth underpins prices for
the service items.
Q1: Discuss the factors that have contributed to
Australia’s inflation rate falling from recent peak
levels.
July 2023 Volume 30 Issue 7
(ISSN Digital 2208-0325)
2
RBA pauses interest rate increases
The recent moderation in inflation is likely to
have been a key factor in the Reserve Bank (RBA)
pausing its program of interest rates increases.
Following both the July and August Board
meetings, the RBA maintained its cash interest
rate target at 4.1%. This pause in policy
tightening follows 12 interest rate increases since
May 2022 when the cash rate was at its
“emergency setting” of just 0.10%.
Source: RBA
With both inflation and consumer spending
showing signs of softening, the significant
tightening of monetary policy that has already
taken place may now be having the desired
effect. The RBA now expects inflation to fall to
3.25% by the end of 2024 and be back within the
target 2% to 3% range by late 2025.
However, despite the evidence of weakening
demand and lower forecasted inflation, the
central bank has stopped short of indicating that
the higher interest rate cycle is complete and has
suggested that further tightening may be
necessary. Following the Board meeting in early
August, the RBA emphasised the degree of
uncertainty in its policy outlook as follows:
“There are though significant uncertainties. Services
price inflation has been surprisingly persistent
overseas and the same could occur in Australia. There
are also uncertainties regarding the lags in the
operation of monetary policy and how firms’ pricing
decisions and wages will respond to the slowing in the
economy at a time when the labour market remains
tight. The outlook for household consumption is also
an ongoing source of uncertainty. Many households
are experiencing a painful squeeze on their finances,
while some are benefiting from rising housing prices,
substantial savings buffers and higher interest income.
In aggregate, consumption growth has slowed
substantially due to the combination of cost-of-living
pressures and higher interest rates.”
Q2: Evaluate the rationale for the RBA’s recent
decision to leave the cash rate unchanged at 4.10%.
Q3: Describe the changes in economic conditions that
would be likely to result in the RBA re-commencing its
program of lifting interest rates.
Business investment at risk from higher
interest rates
Although much of the focus of the impact of
higher interest rates is centered on the
household sector and housing industry,
businesses more broadly are impacted by higher
interest rates. One of the transmission
mechanisms by which higher interest rates effect
the real economy, is via business investment
decisions. If interest rates are higher, the cost of
business borrowing increases, making business
investment spending less viable.
Business investment refers to the purchase by
businesses of items used in the production
process e.g. machinery, computers, the
construction of new factories etc. Business
investment also includes research and
development spending. After declining sharply
during the COVID crisis, business investment has
recovered and has been surprisingly resilient in
the recent period of higher interest rates. Private
sector capital expenditure (business investment)
was 6.6% higher in the year to March 2023, in
real (after inflation) terms.
Despite the recent increase though, real business
investment is currently some 14% below the level
recorded in 2012, when the mining sector was at
the peak of its expansion. In comparison, the size
of the Australian economy has grown by 27%
over the same period. The mining boom
coincided with record high business investment
spending as capital expenditure was required to
develop and expand mines and supporting
infrastructure.