The CPI – Australia’s inflation problem confirmed; over to you RBA…

Today’s Consumer Price Index (CPI) release for the March 2022 quarter highlighted that inflation has well and truly arrived – increasing by 2.1% in the quarter, and by 5.1% through the year. And it’s the largest quarterly and annual jump since the GST-affected price spike over 2000-01, as supply disruptions and geopolitical tensions, combined with a rebounding global economy, push up prices.

Measures of underlying inflation reduce the impact of irregular price changes – such as automotive fuel prices. Trimmed mean inflation grew by 1.4% through the quarter, and 3.7% through the year to March 2022. This is the biggest annual jump in underlying inflation since 2009, and it now sits well above the RBA’s target band for inflation.

Chart: CPI annual change, (%), headline and underlying

Source: Australian Bureau of Statistics
The biggest contributor to the quarterly CPI increase was automotive fuel, which saw an 11% rise in the quarter, and a 35% rise for the year to March 2022. Fuel prices are now 62% higher than the lows reached in mid-2020, when the pandemic first hit Australian shores. Of course, there will be some offset in the June quarter with the temporary fuel excise reduction.

New dwelling purchases by owner-occupiers also soared by 5.7% from the previous quarter, the largest quarterly rise since 2000. The jump largely stems from continued shortages of supplies such as timber, labour shortages and increased freight costs.

There were other significant contributors in this quarter CPI, including tertiary education, which jumped 6.3% through the quarter, reflecting the impact of updated student contribution bands and fees. Food prices also experienced a relatively strong jump, growing 2.8%, with beef (7.6%), vegetables (6.6%), non-alcoholic beverages (5.8%), and fruit (4.9%) the main drivers of the quarterly rise. The spike in food prices has been largely led by higher input costs, combined with COVID-related disruptions in recent months.

Australia therefore has an inflation problem, though not one as bad as many other parts of the world, where it’s at 40-year highs. For the US, prices climbed to their highest rates since the early 1980s, jumping 8.5% through the year to March 2022, largely led by surging energy costs fuelled by the war in Ukraine, and prolonged supply-chain disruptions.  Across Europe, consumer prices soared 7.4% through the year to March 2022. Energy costs, up 44% through the year, were the largest driver.

US longer-term inflation expectations have also edged up, with the market-implied rate over the next five to 10 years jumping to its highest rate since 2014 (though still only at 2.6%).

So, investors still think the US Federal Reserve will get the job done of lowering inflation, but it may take some effort. There are expectations that the US cash rate could reach 2.5% by the end of 2022 (up from 0.5% now).

A similar theme will now play out in Australia, with the RBA about to start lifting rates, likely at either its upcoming May or June meetings. However, the RBA will be mindful of the causes of this inflationary surge. It isn’t due to demand or labour costs – neither of those are doing anything out of the ordinary. And the $A is pushing inflation (gently) down, not up.

Our inflationary surge has been imported – basically driven by COVID and the war in Ukraine.

Unless, and until, wages take off, that says continuing rapid inflation requires COVID- and war-driven cost impacts to steadily worsen. If supply snarls get no worse, and Russia’s war stops increasing commodity prices even further, then inflation will fall away of its own accord, even if supply stays short of demand.

That doesn’t mean the RBA does nothing. But it may mean fewer rate rises on the agenda in Australia than if inflation were more broadly based.