The monthly annual inflation measure for April brings back memories of the old Renee Geyer song “Am I heading in the right direction”. Unfortunately, based on the current data, the answer is no. The interim April result was 6.8%, a very disappointing result given that it followed the downward movement in the quarterly CPI from the December and March quarters.
The drivers for the April number appear to have been increases in petrol prices, as the excise was reinstated, and increases in rents.
In any event, the Consumer Price Index for the major capital cities seems to be among the headline data in the mind of the central bankers as they ponder interest rate movements. We can see the long path of increases and the more recent softening of inflation in the chart below.
The monthly indicator of annual consumer inflation increased from 6.3% in March to hit 6.8% in April. More significantly, the monthly trimmed mean (a more precise measure of underlying inflation) increased from 6.5% in March to 6.7% in April.
As we set out above, property rents had a big impact on the CPI. They were up 6.1% over the year to April, up from 5.3% over the year to March. Low vacancy rates are reflecting strong demand for rental properties and tight rental markets and that is increasing rental costs, as can be observed below.
Other than rents – and in fact the major contributor to inflation – was automotive fuel, the average cost of which rose 9.5% in the year to April, following a fall of 8.2% in March. However, this is not as concerning as market-driven rental increases, as the fuel cost increase is primarily the result of the reinstatement of the fuel excise tax.
The 22 cents per litre cut in fuel excise saw automotive fuel prices fall 13.8% in April 2022. The April 2022 dip in fuel prices when the excise was reduced no longer contributes to the annual movement for April 2023. By contrast, recent rises in rental prices will remain in the CPI for another year.
As we now know, following the RBA meeting on 6th June, these inflation numbers contributed to a decision to lift the official cash rate by a further 0.25% to 4.10%. Refer elsewhere in Stats Count for a fuller discussion of the “narrow path to the soft landing” in the review of the recent GDP data.
However, in terms of the inflation outlook, the May Statement on Monetary Policy indicates forecasts remain relatively unchanged, reflecting a return to target band inflation by the first half of 2025.
The RBA’s recent official interest rate decision suggests the Bank is concerned that the trajectory back to the target band may have moved beyond forecast parameters, thereby requiring further action to bring the rate down.
In any discussion about inflation, the key is to keep inflationary expectations anchored.
In recent weeks, the RBA has mentioned wages increases and the potential concern that if the recent increases in the minimum wage and award rates transferred to all workers, then the effect would be inflationary. The rate increases are all about pulling money out of the economy and keeping those expectations in check.
It is only a couple of years ago that the same RBA governor was encouraging the economy to ‘unleash its animal spirits’ and was provoking debate on getting wages moving.
The argument that wages increases are potentially going to contribute to inflation comes at a time when the profit share of GDP remains at record levels and by contrast, the wages share is at record lows. Leaving aside current inflation, the structural problem in the economy is not wages increases.
This has been the subject of extensive coverage in the media in recent months. Some commentators have offered the view that above average profits are the result of price increases being above input costs.
For example, the ACCC has raised concerns that lack of competition has enabled QANTAS to expand profits at the expense of consumer service. Commenting in the final report on Airline competition published in June 2023 that “while strong demand and high airfares across the industry have been a key reason for the Qantas Group’s strong profitable performance, it may also reflect a change in the competitive landscape since early 2020”.
At a macro level, Treasury and RBA research has suggested that while profits overall are up, if one removes mining profits, then profits for the rest of the economy are tracking at more normal levels.
The recent OECD World Economic Outlook suggests a more nuanced outcome, where there has been a contribution to inflation from both higher business profits and higher unit labour costs.
For Australia, the past five quarters have seen growing contributions to inflation from unit profits (red column), with a more even split in the last quarter of 2022.
Taking a “bob each way”, the report comments that:
“A key policy issue is whether the observed aggregate increase in unit profits reflects a generalised lack of competitive pressures throughout the economy, or specific factors that have contributed to strong profit growth in a few sectors or in a subset of firms.”
The report also looks at the main sectors where the profits are being generated.
The data shows the mining and utilities sectors have been the major contributor to profits, accounting for 4% of the average economy, but greater than 40% of the rise of unit profits in 2022. Despite this, in the last quarter of 2022 manufacturing and services sector profits were also up.
Inflation is up and potentially looking a little ‘sticky’ right now. Structural challenges in the economy create contradictions like higher rents that are contributing to higher wages demands. Both are inflationary and in the sights of the RBA as it increases interest rates. But wages are structurally too low as a proportion of total GDP, while profits – some linked to inflationary higher prices – are growing.
Interest rates are a blunt object being used to batter inflation into submission. The risk is that the big stick beats the economy and cruels the animal from expressing its animal spirits long into the future.