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Inflation rose in the March quarter

Australia’s headline measure of inflation, the Consumer Price Index (CPI), rose 1.0 per cent in the March 2024 quarter and 3.6 per cent annually, according to the latest data from the Australian Bureau of Statistics (ABS). That is unwelcome news at a time when the central bank is fixated on driving inflation lower and has proven itself prepared to put the economy to the sword if it feels the necessity.

Commenting on the March quarter result, Michelle Marquardt, ABS head of prices statistics, said:

“The CPI rose 1.0 per cent in the March quarter, higher than the 0.6 per cent rise in the December 2023 quarter.

“Annually, the CPI rose 3.6 per cent to the March 2024 quarter. While prices continued to rise for most goods and services, annual CPI inflation was down from 4.1 per cent last quarter and has fallen from the peak of 7.8 per cent in December 2022.”

Until the March quarter result was known, inflation appeared to be tracking suitably, likely to land back in the Reserve Bank of Australia’s (RBA) target of 2-3% per annum toward the end of 2024. That is now placed in jeopardy, leading to (incorrect as it happens) speculation from some economists there would be a further tightening of monetary policy. That is, a rise in interest rates.

We can see below the annual trend for inflation continues to fall, but its journey is made more difficult given the March quarter result.

Ultimately the headline number is one thing, but the big issue in the March quarter data is the increase in underlying inflation, which is what the RBA tracks, because it is less transient and harder to shift, pointing to the medium-term pace at which prices are moving.

The main measure of underlying inflation is the ‘Trimmed Mean’, which measures core inflation by removing a range of volatilities. Importantly, the Trimmed Mean was 1.0% in the March quarter, up from the 0.8% in the previous quarter.

In the endless search for context and causality in inflation modelling, we need look no further that the challenge of “sticky” services inflation. Whilst down to 4.3% in the March quarter, from 4.6% in the previous quarter, services were still among the highest contributors to inflation.

If we drill down further to examine specific expenditure class items, the top four contributors were all services.

This upward move in underlying inflation in the March quarter has prompted the RBA to revise their forecasts, which were released in the May Statement on Monetary Policy. The RBA is now forecasting the Trimmed Mean to move up from 3.1% in December 2024 to 3.8%.

That explains what is happening, but not really why services are tracking so much higher. That is a topic for another day, but thinking about the structural challenges for the national economy and we can observe labour shortages are part of the mix.

There is a counter to this argument that inflation is proving to be sticky. Greg Jericho, in The Guardian, observed that the non-accelerating rate of unemployment – the NARU – which is the level of unemployment at which inflation will stop rising is 4.5%. However, right now, unemployment is just 3.8% and yet, inflation has fallen on an annualised basis from 4.1% to 3.6%.

Jericho observes that some further increase in interest rates will do nothing to reduce the price pressures on most of the major services, that are contributing the most to current inflation.

The counter-argument aside, any further upside “shocks” in the June quarter CPI to be published at the end of July, would inevitably result in increased pressure on interest rates.

Whether the nation dodges that bullet will depend on how “tight” the economy remains. On this front, the RBA has some good news (albeit qualified). In the RBA assessment of spare capacity in the economy, the range of indicators they track show some easing from the very tight levels in late 2022.

The emphasis on labour market factors among the indicators that drive underlying inflation is significant. All measures have improved, but to date, not to the point where they are helping drag services inflation back to square, just yet. The RBA has declared itself a reluctant hiker when it comes to interest rates, and it is clinging to the capacity data as evidence it may not feel compelled to increase interest rates again.

A sophisticated economy moves slowly. How long it takes for services to come back into check is uncertain, but it is longer than for goods. Why is that so? Because services are labour centric and higher inflation causes the workforce – not unreasonably – to seek higher wages. The feedback loop is relatively strong and takes time to wind back down. Despite the March quarter, inflation is however, heading in the right direction.

Posted Date: May 13, 2024

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