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Latest inflation data a window onto domestic economy’s challenges

Australia’s annual inflation rate – the Consumer Price Index (CPI) – ticked back up into ‘target band’ territory over the financial year just ended. At 2.1% for the year-ended June, the CPI was within the RBA’s 2% to 3% target, but barely. What the headline inflation data does not show is some endemic weaknesses that are weighing upon the domestic economy.

Australian headline CPI data is shown in the chart below.

fig5

To go straight to the dashboard and take a closer look at the data, click here.

While the slight tick up in the final quarter of the year-end line is certainly positive news, it needs to be viewed in the context of a declining CPI trend. And one moment above 2.0% is not a stable inflation rate, especially when the June quarter shows headline inflation lower than the March quarter.

Inflation is a tricky thing. Too much is a bad thing, and too little and you run the risk of a negative spiral.

For the national economy, what makes up its energy – the things we spend money on – is critical to whether it puts the energy created by expenditure to good effect (productivity and economic growth) or to less good effect (especially narrowly held stores of wealth).

So, we are always minded to not just the CPI, but rather to what makes it up. The news on that front is not good. As Greg Jericho wrote in The Guardian in late July:

“The biggest contributors to inflation growth over the past nine months have been petrol, health, tobacco and education costs. Aside from tobacco, those are pretty hard categories to avoid spending money on.”

He goes on to say that in the main, these are items that households cannot avoid. Jericho narrows in even further, taking out the largely discretionary expenditure items of tobacco and alcohol price rises. His chart, presented below, shows annualized inflation growth of just 1.7% per annum when these items are removed from the CPI.

fig6

So, we extract non-essential items and the main driver of prices growth in Australia is definitively unavoidable household expenditure. Drilling into this, Jericho’s next chart really underscores where inflation growth is directed, and moreover, compares that to average private sector wages growth.

fig7

The point on wages growth should not be lost on anyone now that it has been a hot topic for the last two years. The point, at its simplest is that wages are not keeping up with the price of things on which most households have to spend money.

Right now, it seems that Australia’s inflation is overly-skewed towards less productive elements of our national economic metabolism.

In this context, imagine for a moment, the impact of small but regular increases in official interest rates, followed through with mortgage cost increases. Capacity to expend on things other than mortgages would reduce further, dragging inflation and economic growth back relatively sharply. 

An interest rate rise is difficult to imagine for some time to come, and certainly we are unlikely to see a sustained round of increases until wages growth is significantly stronger. Slow wages growth is not actually new, the latest Household Income and Labour Dynamics (HILDA) study from the Melbourne Institute demonstrates wages have been stagnant since the GFC, in real terms.

In 2009, in real terms, the median Australian household had after tax income of $79,160, compared with, in 2016, $79,244. That is no increase at all, as the chart below shows, noting that ‘real’ income refers not to the cash income, but its spending power, after adjustment for inflation.

fig8

Greg Jericho, in a different article, referred to this in detail and compared Australia with the US, with the chart below. He wrote:

“The survey highlights just how poor Australian households have been doing since the GFC. While thanks to the mining boom, the median disposable incomes of Australian households rose much faster than in the USA, since the GFC both nations have been doing it tough. In the US incomes went backwards by more than here, but since 2009 a case could be made that Australian households have made less progress.”

fig9

So if we summarise all of this, we find Australia has barely acceptable inflation, mainly skewed toward unavoidable and less productive expenditure items, coupled with a long period of poor wages growth in local terms and compared to our major culturally similar trading counterpart.

There may, in all of this, be just a hint that the Australian economy is restructuring itself, in part towards a sustained period of lower economic growth, underpinned by slower consumption growth and correspondingly lower wages growth. Demographic factors could be at play, as has occurred in Japan over the last three decades. But the difference in Australia appears to be that the wrong prices are increasing 

There is much to ponder right now, on the future of the Australian economy. 

Posted Date: August 2, 2018

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