Inflation is back in the news, or at least the looming threat of its revival.
Australians are already enduring higher petrol prices and reports mount by the day about disruptions to trade caused by the Covid pandemic.
Carmakers are struggling to secure computer chips for the cars, restaurant owners say the cost of food imports is soaring, and local farmers say the cost of inputs is doubling in price if not more.
But is the inflationary dragon really stirring and should we fret that central banks including Australia’s may soon follow New Zealand’s move this month and lift official interest rates? And is inflation such a bad thing, especially if wages rise faster?
Australia’s consumer price index for the September quarter, due out tomorrow at 11.30 AEDT, should provide the clearest signal yet of whether price rises are gathering pace.
The consumer price index – what is it?
As the name suggests, the CPI tracks the average change over time in prices paid by households for a set basket of goods and services.
Statisticians have been tracking national price changes since federation in 1901, adding the innovation of specific weights based on the proportion of goods bought in 1948. Since 2018, the basket has been adjusted annually to reflect consumer changes.
Perhaps not surprisingly, housing makes up the largest overall weighting on the index, at about one-quarter.
The CPI, though, does not include changes in land prices, so the soaring price of housing – 25% in the past year in Sydney alone – is ignored unless the home being bought is a new one.
That’s one key reason why the CPI is not the same thing as a cost of living index, of which the Australian Bureau of Statistics has several.
(The index also excludes changes in the value of other assets, such as superannuation and cryptocurrencies.)
Why does the CPI matter?
The CPI is right up there among the mostly closely examined economic gauges, along with gross domestic product growth and unemployment rates.
Central banks, including the Reserve Bank of Australia, base their interest rates specifically on how inflation is faring, and that directly influences the cost of borrowing for mortgages and other loans.
Indeed, interest rates have long been the RBA’s main tool to steer the wider economy. Since the 1990s, the central bank has attempted to keep inflation within a 2-3% annual range.
It deems the target to be the “appropriate” annual rate “over time” to ensure CPI is “sufficiently low that it does not materially distort economic decisions in the community”. More on these distortions later.
Since the aftermath of the global financial crisis in 2008, though, the CPI has remained below the low end of that target. Or at least until the June quarter of this year, when it jumped to 3.8%.
That June quarter figure included some distortions, such as the return of costs for childcare after the same period a year ago when the federal government temporarily made services free to assist families coping with the first Covid lockdowns.
The RBA and others zeroed in on the so-called trimmed mean measure of the CPI, which stripped out short-term distortions. That figure came in at 1.6%, or less than that 2% end of the range.
Over time, the general CPI and its trimmed mean or weighted median – another inflation measure – typically converge, says John Hawkins, a former RBA forecaster now at the University of Canberra.
Is this week’s CPI figure particularly interesting?
Yes. Since the June figures were released, a range of trading partners have reported higher inflation rates, with more likely if consumers and companies continue to scramble to secure access to goods perceived to be in short supply.
According to Katrina Ell, a senior economist with Moody’s Analytics in Sydney, Wednesday’s number stands to be “an incredibly important inflation print”.
Our neighbours across the ditch in New Zealand just posted their fastest rise in inflation, at least on quarterly basis, since 1987. Australia and New Zealand share many market similarities, not least looming construction bottlenecks and a reliance on imports for many finished goods, Ell says.
Australia’s September CPI is unlikely to approach the Kiwis’ 4.9% annualised reading for that period. Still, Ell predicts Australia’s CPI will be 2.4% – compared with a market consensus closer to 3% – but even that rate is notable since half of the economy was mostly in Covid-induced hibernation.
“That’s really significant because, obviously, Victoria and New South Wales were in extended lockdowns through part or all of the September quarter,” Ell says. “So we would have expected to see a slowdown” in inflation if not for those global disruptions.
“We’re seeing severe global supply chain disruptions and that’s causing prices to increase, not just in Australia but also, you know, across the globe,” Ell says.
Other countries reporting higher inflation readings above 4% include the normally inflation-allergic Germany, while others such as the US and the UK are in the 5% range or soon will be.
Higher energy prices are one propellant of those higher inflation rates because of gas and other fuel shortages. In Australia, though, electricity prices have been falling sharply in part because of the advance of renewable energy.
Is it time to panic?
No. Short of an inflation spike come Wednesday, most economists are sanguine about the near-term prospects for prices.
Hawkins, who also worked as a forecaster for the commonwealth Treasury, says the RBA is showing no signs of getting twitchy about a rise.
He highlights a speech by the RBA governor, Philip Lowe, in July that sums up how the central bank planned to “look through” the many short-term distortions created by the pandemic.
Lowe noted how the RBA was watching if wages were starting to pick up, one sign that higher inflation too might not be far behind. That prospect is made more likely the longer international borders remained largely closed to labour.
“Some workers have received sizeable wage increases. However, the spillover effects to the broader labour market have been limited to date, and wage increases remain modest for most workers,” Lowe said. “Most firms retain their strong focus on cost control, with many preferring to wait things out until the borders open, and ration output in the meantime.”
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Hawkins says, “if wages start growing faster, then that probably would translate into a bit higher inflation, but that just takes inflation from something under 2 to somewhere between 2-3 [%].
“And that’s only getting back into the target range [for the RBA] so it wouldn’t be anything to be particularly concerned about” he added. “It would only be if it looked like inflation was heading to 3% then 4% then 5%, then that obviously would be a concern.”
Meanwhile, there are other signs that industries, such as tourism, are struggling to find workers as economies reopen. Anecdotally at least, staff have more power to bargain for fatter pay packets.
Hawkins, though, says there is little reason at this point to worry about a period of slow growth and high inflation, dubbed “stagflation” after an extended period during the 1970s.
“There’s a question about whether the economy will recover and we will have strong activity and strong inflation,” he says. “But it’s even harder to see a scenario where the economy stays really weak, and wages take off and inflation goes up.”
Any dragons here?
Richard Denniss, the chief economist of the Australia Institute, doesn’t view inflation as such a dragon to be fought off anyway.
“The sort of inflation bogeyman has been used for decades to kind of, you know, scare us away from asking for nice things,” Denniss says. These include higher wages.
“The RBA has spectacularly failed in targeting inflation of 2-3%” for many years.
“No one wants high inflation, but also no one wants higher unemployment, and also no one wants low wages,” Denniss says.
To his thinking, it’s no accident that employers have stoked an inflationary scare campaign to keep salary growth at the slowest pace in history.
“It’s very profitable to jump at some shadows, especially for people that are trying to keep wages down,” Denniss says.
The unemployment rate remains about 10% if those who recently dropped out of the jobs market return, and the hours worked in the economy remains well down because the pandemic.
As a result, Denniss predicts it will take more than a couple of blips in the CPI to prompt the RBA – which he calls the most “conservative, inflation-obsessed institution in Australia” – to lift its current record-low official interest rates.