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May’s annualised inflation rate a shocker

Reported in May, Australia’s annual inflation rate shifted up a gear, with the headline inflation rate lifting to 4.0% from 3.6% in April. This is the latest in the ABS’ publication of a useful but less extensive monthly annual CPI. The devil is in the detail and that makes the less detailed monthly data a little dangerous as a basis for decision-making. We wouldn’t day trade our super, so perhaps we shouldn’t month trade our inflation rate.

While we note the limits of monthly inflation rates, it is harder to avoid the multiple months of data. The big problem is the inflation trend has been upwards since March.

Compounding the concern for policymakers is the increase in the trimmed mean (the measure of underlying inflation, upon which the RBA relies). After moving down in February to an annualised 3.9%, it has now moved up to 4.4%.

If we look at the major movement by expenditure class, we observe the major impact in areas such as Insurance (+7.8%) Housing (+5.2%), Food and non-alcoholic beverages (+3.3%), Transport (+4.9 %) and Alcohol and tobacco (+6.7%).

While housing costs have eased from their peak in 2022, the breakdown shows rents increased 7.4% for the year, reflecting a tight rental market across the country. The annual rise in new dwelling prices was more muted (+4.9%) with builders passing on higher costs for labour and materials as contractual opportunities allow.

This is an important point. Many building contracts are fixed price and builders have been forced to deliver against ‘old’ and often unsustainable contracts. There may well be a lag effect for some time, as new building contracts take up and account for the current materiel and labour costs.

The problem of prices – for rents as well as for new builds and purchases of existing homes – rising faster than incomes is how do you catch up? This impossible equation is evident in the impact on building costs since the ‘boom’ in 2021. The index is 37% higher than at the onset of the pandemic in 2020.

Reporting in the Australian Financial Review, Michael Read commented:

“After steadily falling from mid-2022 to mid-2023, inflation in the cost of building a new home has become entrenched at 5 per cent, due in part to a substantial pipeline of state government infrastructure projects putting upward pressure on building material and labour costs.”

As we described at the outset, the real problem appears to lie with the ‘sticky’ inflation in the services sector. The problem, at its simplest, is that services inflation is still trending up (+4.8% annualised), while the decline in goods inflation which drove much of the fall in inflation last year has done its work and is now tapering off.

The May monthly CPI has few positives, leaving an anxious nation (and some worried central bankers and policy makers) waiting with more than a soupçon of interest to see the more authoritative quarterly CPI for June. That will allow an assessment of whether the volatility of monthly numbers remains, or whether inflation has in fact remained on a downward track.

If the quarterly inflation data does show a resurgence in price increases, especially in the sticky services sector, there is investor expectation, as Michael Read wrote in the Australian Financial Review, of a one in three chance of interest rates being increased by the RBA in August. Read’s stable-mate, John Kehoe described the RBA as operating on a narrowing path with “…now only one more bad inflation report away from doing what it really doesn’t want to: raising interest rates before the federal election.”

Just like we’ll be unified in cheering for our team in Paris, team Australia will be cheering for a lower June quarter inflation number.

Posted Date: July 10, 2024

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