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Inflation nearly too low for comfort

Sure today's inflation figures are low, but inflation is actually lower than it looks. That means the Reserve Bank doesn’t just “have room” to loosen monetary policy, as Julia Gillard puts it – the Reserve Bank is forced to cut rates to stimulate the economy to keep inflation within its target range.

The headline CPI rise of 1.6 per cent is certainly a low number and the Australian Bureau of Statistics’ seasonally version is lower again at 1.5 per cent. (The two biggest areas of price rises, pharmaceuticals and secondary education, always jump in the March quarter thanks to the structure of the PBS and when schools put up their fees for the new year.)

But those headline figures don’t matter all that much to the RBA which concentrates on the “trimmed mean” and “weighted median” measures that try to exclude the extreme movements both up and down.

Those measures for the year to the end of March are down to 2.2 and 2.1 per cent respectively – the bottom of the RBA’s comfort range but still within it and well down on the 2.6 per cent annual score in the December quarter.

The thing about annual figures though is that the June quarter is a long time ago with plenty of global financial turmoil passing under the bridge since then. What might concern the RBA a little more is what happens when you annualise the TM and WM measures over the most recent six months: you get 1.8 per cent, falling below the target.

The RBA’s job is to keep inflation within the 2 to 3 per cent range “over the cycle” so it’s not going to panic about a couple of sets of figures and dramatically slash rates, just as it didn’t dramatically increase rates when it’s measures were running above 3 per cent, but that annualised figure should be enough to pencil in another 25 points reduction in the cash rate at the board’s June meeting on top of the 25 per cent cut now guaranteed on May 1.

There will be some who will argue that today’s figures are low enough to allow a 50 per cent cut straight away, but I suspect that would smell a little too much of unseemly haste for a cautious institution. And there is the federal budget to consider, the need to see just how solid the promised fiscal drag of around 2.5 per cent turns out to be.

Besides, it is the expectation of rates as much as the reality of them that’s supposed to do the trick for consumer confidence.

“Rates are coming down” has plenty of promise in it, while “rates are down” carries an inference that that is as good as it’s going to get and that the next move might well be up.

And the low inflation numbers, even though lower than they at first look, still have to be kept in some perspective. The capex boom is still growing with its impact yet to be fully felt.

While the labour market is soft, unemployment is still low by historical standards. The necessary but painful restructuring of our economy into one of stronger productivity growth and greater value-add still has a long way to run.

Furthermore, a fair whack of the falling prices are only another seasonal disaster away from rising again and the great challenges of managing higher health costs and the need for increased education investment remain out there, never mind March quarter seasonal factors.

Solly Lew and Paul Howes will get their May 1 rate cut and probably a June cut as well. The extent to which it puts a spring in the consumer’s step is not certain as we have talked ourselves into a level of domestic political concern and continue to be prey to all the scary headlines about the “old world” even while our world, our weighted trading partners, are motoring at about average speed.

Finally, there is the public disbelief factor: we remember our last electricity bill and have become convinced the cost of living is rising outrageously. Egged on by the usual tabloid media tendencies, most people simply won’t believe the ABS measure of inflation, plus we have the spectacle of the least unpopular side of politics forecasting that we’ll suffer economic and inflationary disaster at the hands of the carbon tax.

Even when you get what you wish for, sometimes it’s not much.

Michael Pascoe is a BusinessDay contributing editor


40 comments

  • The real question here is not whether the RBA will cut rates (it will), but rather whether the banks (Big Four and others) will pass on most or even any of the cut. The Big Four have made it clear they no longer listen to the RBA and set their own rates outside of any RBA cycle. Apart from angry comments from Wayne Swan and some teeth gnashing from customers, there's nothing that can be done to coerce banks into cutting rates.

    Commenter
    Michael
    Location
    Adelaide
    Date and time
    April 24, 2012, 12:51PM
    • Given that banks are now raising rates independantly of the usual rate cycle window leads me to expect there is a higher likelyhood that they can pass the whole rate cut on. Now they have more flexibility they don't have to think these things as far ahead - and guess how many more decreases they will have to play with for example.

      Commenter
      Damien
      Location
      Adelaide
      Date and time
      April 24, 2012, 1:15PM
    • Agree. Interest rate cuts will just help banks. Lowering 0.25 will help the banks to put up their interest rates few times and just lower once with RBA.

      Commenter
      user
      Location
      Melbourne
      Date and time
      April 24, 2012, 1:20PM
    • I'm not sure it's true that "no longer listen to the RBA" when setting interest rates. Bank funding depends on a number of sources, and the RBA overnight cash rate is only one. It does play a part.

      Commenter
      Reality Cheque or Savings?
      Location
      Sydney
      Date and time
      April 24, 2012, 1:51PM
    • No, the big question here is why everyone feels that a rate cut will improve consumer confidence when the fastest growing sector is actually retirees who own their homes and rely on interest INCOME. A rat cut more than likely will lower consumer confidence. The 30% of Australians with a mortgage (less the whatever % with fixed rates) might get a few extra dollars, but since they know that they've overpaid for their home (those who bought since 2006), that extra will be going straight on the mortgage, not into the economy.

      Commenter
      Black is white
      Location
      White is Black
      Date and time
      April 24, 2012, 2:43PM
    • Julia sounds more desperate by the day--she should remember that only 30% of Australian's have a mortage. The rest of us depend on a reasonable level of interest return to survive. When rates go down, we'll stop spending and there's a lot of us.

      Commenter
      kev the labor hater
      Location
      out there
      Date and time
      April 24, 2012, 2:46PM
    • Inflation seems low right now, but over the past 10 years it's averaged closer to 3% than 2.5% (which it's supposed to). Seems like when CPI comes in low, there's a clamoring for cuts, but when it comes in high, everyone says to hold off. The consequence is the RBA is constantly above its inflation target and has lost any real credibility on that front. As an employer, every year staff say to me "I want a 3% raise to cover inflation".

      Also, I suspect any cut will hurt savers and deposit holders who vastly outnumber mortgage holder, so might not be as stimulatory as they expect. Better to hold their fire in case Europe goes belly up. We very well might need it.

      Commenter
      LiamH
      Date and time
      April 24, 2012, 5:01PM
  • What is the obsession with RBA cutting rates and by how much, when the banks have indicated they will not be following their lead and will make their own decisions of if and when to cut and raise rates. The RBA is effectively irrelevant now.

    Commenter
    CJ
    Location
    Melbourne
    Date and time
    April 24, 2012, 12:54PM
    • Not quite true.

      While the RBA can't directly set mortgage rates any more, the cash rate still anchors the yield curve. The relationship is more complicated and they might have to change the cash rate more than they used to to have the same overall effect, however they can still move mortgage rates.

      The fact they are not doing this tells you that, including all the non-cash-rate rises the banks have put through, the RBA thinks mortgage rates are about where they should be. RBA spokes-things have essentially acknowledged this on several occasions.

      On a more general note, the fact that for a while the RBA could directly set mortgage rates through the cash rate was a historical accident that arose because non-banks adopted securitisation funding which was set on a short-term basis (3 months), and the banks copied their rate behaviour for marketing reasons. There is no real reason why a direct relationship between the cash rate and bank mortgage rates should exist.

      Commenter
      DaveC
      Location
      Sydney
      Date and time
      April 24, 2012, 2:51PM
    • When I do the shopping I balance price and cost. This is what more of us should do when shopping for bank loans. The more who do the stronger the message to banks as to what they should do when they are tempted to increase their margins at borrowers' expense. If you believe in market-forces make them work for you.

      Commenter
      Clive
      Location
      Manly West
      Date and time
      April 24, 2012, 3:38PM

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