Mild inflation still leaves RBA with work to do
While today's consumer price index is a pleasant surprise on the downside, it is a mild one. Core inflation has been running low enough to allow the Reserve Bank to trim rates next month if it so wishes, but not so low as to push it in that direction.
Six months on, the inflationary sky still hasn't fallen under the weight of the carbon tax and is not likely to. Household electricity and gas are up a very fat 17.7 and 17.3 per cent over the year to December, but that cost jump seems to have been contained. The breakdown of the CPI components actually shows a fractional drop in electricity and gas prices in the December quarter after their big surge in the September period.
The main movements in the December 2012 quarter CPI are more or less – and mainly less – what they were in the December 2011 period. Surprise, surprise – domestic holiday accommodation and airfares rise in peak holiday season, but they're 1.3 per cent lower than they were a year ago.
Cost of living
Goaded by politicians and tabloid media, the man and woman in the street nonetheless will believe they are suffering under severe cost of living increases that the Australian Bureau of Statistics somehow misses. It remains human nature to be mindful of the pain of those sharply higher utility prices and rent, but to totally forget that food and clothing have been practically flat for a couple of years while incomes have risen.
The numbers show why Gerry Harvey feels so much pain – the prices of the audio, visual and computer group were down 14.2 per cent over the last year, which means that, at the same profit margin, he would have to sell 16 per cent more stuff to maintain the same bottom line, never mind the extra logistics and labour costs involved in bigger volumes.
But the breakdown also shows why inflation isn't dead as an issue for the RBA, why it can't afford to wildly slash interest rates as the usual suspects keep suggesting.
Over the quarter and the year, the price of tradeable goods – those whose prices are mainly set by the international markets – fell by 0.4 per cent. Non-tradeable goods prices rose by 0.7 per cent last quarter and by 3.9 per cent over the year. Tradeable goods make up about 40 per cent of the CPI while the non-tradeables, those whose prices are set by the domestic market, make up the rest.
Thus our inflation rate has been kept down by the impact of a strong currency and a global economy with excess capacity that results in plenty of discounting during a period of weakness. The currency impact only lasts while the Aussie is rising firming – a period of stability removes the advantage and a fall reverses it.
The outlook for the old rich world remains soft, thus helping maintain the excess capacity, and the escalation of the currency wars by Japan should keep our dollar strong, for better and for worse, but left to our own domestic devices, inflation has not been tamed.
The RBA board minutes have tended to include a phrase or two to remind us of that. Yes, the bank's core measures of the trimmed mean and weighted mean both printed at 2.3 per cent for the year and 0.6 and 0.5 per cent respectively for the quarter. But that underlying split between tradeable and non-tradeables indicates the mandarins can only be confident about inflation staying within the target zone for a year or two.
In an interview with the Australian Financial Review that was largely missed just before Christmas, governor Glenn Stevens spelt out the difference between the Australian and Swiss situations when it comes to trying to constrain a rampant currency. Before getting carried away with the idea of today's pleasant-but-mild surprise driving our rates much lower, it's worth understanding how our underlying inflation limits our options:
AFR: What would you say to manufacturers who are obviously doing it tough? And why can't you just do what the central bank of Switzerland has just done – put a cap on the dollar at what you regard as the right rate?
Stevens: Well let's talk about what the Swiss did. Firstly, they had a very high exchange rate by historical circumstances. Under pronounced upper pressure they did quite a lot of intervention of the conventional kind and they weren't able to hold it.
The macroeconomic backdrop that they had was price deflation, which we don't have, and then it shot up from there and it's reached an exceptionally high level, and that's the level where they've said 'we're now going to cap it', and that seems to be working for them.
There's been a very large build-up of foreign currency reserves – you know 70 per cent of Switzerland's annual GDP worth – if we had to do that, that is a lot of money. In our case we would be taking a negative carry on that position, because we would essentially be selling the foreigners assets earning 3 per cent, and holding their assets earning nothing.
The Swiss aren't in that position because their rates, their interest rates are zero. This is the other thing – they have no other device left for easing policy in an environment of price deflation, well we're not in that environment at all.
So I think there are a number of differences between the Swiss situation and ours that are quite fundamental to why we're not at this point doing what they're doing, and I'd very much hope we don't get to that point.
Michael Pascoe is a BusinessDay contributing editor.