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What happened to Australian inflation last week? Charts of the week

Lewis Jackson  |  01 Nov 2021Text size  Decrease  Increase  |  
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Inflation made landfall in Australia last Wednesday. The broad Consumer Price Index rose 0.8% for the September quarter, jumping 3% year-on-year. The Reserve Bank’s preferred measure edged into the bank’s 2%-3% target range for the first time since 2015.

Markets took the news badly. The ASX 200 dropped 0.5% following the 11.30am data release. Bonds sold off on the expectation higher prices would force the Reserve Bank to raise interest rates ahead of schedule.

On paper, the RBA is still committed to a first-rate hike sometime in 2024. But markets have broken ranks. Shane Oliver, chief economist at AMP Capital, is forecasting two small rate hikes at the end of next year. Bond markets are pricing as many as five between now and the end of 2022.

The bank may be signalling a change of mind. On Friday, it let bond traders breach its commitment to keep 3-year bond yields pegged to the cash rate, a policy called yield curve control. A week earlier the RBA had spent $1 billion trying to stop them. Seven day later, nothing.

In today’s Charts of the week, we wade into the latest inflation numbers and why they’ve got investors worried about higher rates.

Don’t let bananas cause rate hikes

Markets usually look at two measures of inflation. The most common is the Consumer Price Index (CPI), or headline inflation. It measures price changes for those goods and services used by metropolitan households. Each quarter the Australian Bureau of Statistics’ (ABS) collects 900,000 price quotes for goods and services to create the CPI. The basket includes everything from petrol to berries.

A second set of metrics take the CPI and remove volatile prices. They’re collectively known as underlying or core inflation. The logic is that one-off spikes shouldn’t be confused with sustained and broad price changes—the RBA doesn’t want to lift rates if a spike in banana prices causes the CPI to jump temporarily.

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The RBA’s preferred measure of underlying inflation is called trimmed mean. It takes the CPI and lops off the biggest price changes in each direction. It aims to screen out false alarms while telling the RBA when prices are widely increasing and the bank needs to raise rates.

Core inflation edges into the RBA’s range

Last Wednesday ‘trimmed mean’ inflation surprised markets by jumping higher.

The RBA's trimmed mean rose 0.7% for the September quarter and 2.1% year-on-year. It was the biggest year-on-year change since 2015.

Hayden Dimes, an economist at ANZ, says the change in trimmed mean shows price rises are broad based. Just under half the items in the CPI basket were growing at more than 2.5%, he says.

“It's a strong indication that in Australia there is more inflationary pressure than people had anticipated. Thus the bond market sell off,” Dimes says.

Petrol leads the way with help from homebuyers

Fuel and house prices were the biggest changes in the September quarter, mirroring the dramas in global energy markets and the Australian property sector.

Fuel was the biggest mover in the September quarter, jumping 7.1% as the price of Brent crude oil, the global benchmark, hit the highest level since 2014.

According to the ABS, the average daily price for unleaded petrol reached a record high of $1.65 a litre.

High fuel prices make the RBA anxious. Consumers use the petrol pump as a gauge for how they feel about prices in the broader economy. Rises at the former can influence expectations for the latter.

Higher home prices were the second biggest contributor to September’s numbers. Prices for new dwellings rose 3.3%, the largest shift since 2000. The story was part housing boom and part builders passing on the costs of higher materials, such as lumber.

People buy furniture but not clothes

Inflation watchers were also concerned by price rises across a broad range of consumer goods and services.

Homebuyers looking to deck out their new purchases sent furniture prices up 3.8%, followed closely by childcare at 2.1% as the government’s post-pandemic free childcare programs ended.

Computer equipment and motor vehicles both rose as demand came up against a global shortage of the semi-conductors necessary for both products.

ANZ's Dimes is concerned prices rose despite Sydney and Melbourne having spent much of the quarter in lockdown. He’s watching to see what happens now people are free to leave the home and spend down their savings.

“Even in lockdown, firms felt they could pass on price rises," he says. That’s a stark contrast to last year where there was much greater hesitation to pass that on."

“You’re already got supply side cost pressures and then you add demand for goods and services from reopening.”

Clothing retailers were a dampener. Clothing and footwear fell 3.8% as retailers slashed prices to shift the unworn stock after millions spent winter in lockdown.

Reserve bank to watch wages and supply chains

All eyes are now on what happens with international supply chains and wage growth, says Dimes.

Inflation could dip back down if bottlenecks unclog and shortages for essential components such as semiconductors ease. Elevated goods prices are likely to slip as consumers leave home and spend on services—more haircuts and less furniture.

The most important piece of the puzzle is wage growth. Dimes agrees with Governor Philip Lowe that sustainably high inflation requires wage growth. It’s the major cost for most businesses and a big driver of consumer spending.

The next batch of wage data is due on 17 November. In the June quarter, wages rose 1.7% year-on-year, still below the pre-pandemic rate of 2.1% and well off where the RBA would like to see it.

Wednesday’s numbers will force a rethink at the RBA, says Dimes. The economy and labour market is doing better than the bank had forecast. That could mean an accelerated end to their quantitative easing program and an acceleration of the interest rate hike timetable.
“This inflation data does change the story for them," he says. "Most likely they come out and say that a hike is likely in 2023."

The RBA next meets on Tuesday, 2 November.

How does inflation affect investors and the stock market?

There’s no simple link between inflation and the share market. Some companies will be resilient in an inflationary environment—firms like Apple can pass on higher costs to customers without turning them away. Those unable to pass on costs could see inflation cut into margins.

On balance, stocks tend to do ok over the long haul when inflation rises, according to Morningstar’s Russel Kinnel, in his review of inflation hedges.

Then there’s the higher interest rates that central banks use to fight inflation. Higher rates hurt equity market valuations and any unexpected hikes could cause disorderly adjustments. They also raise borrowing costs and cut into company profits. On the other hand, higher rates boost margins for banks and mean better deposit rates for investors holding cash.

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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