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Inflation – elevated, but within expectations

Yesterday's Consumer Price Index (CPI) release for the September 2021 quarter provides some confirmation that inflation is building. The CPI increased by 0.8% this quarter, with annual inflation rising 3.0% - and Australia’s headline inflation remains higher than pre-COVID growth rates, as supply disruptions and constraints affect prices.

Measures of underlying inflation reduce the impact of irregular price changes, such as automotive fuel prices. Trimmed mean inflation, for example, and one of the Reserve Bank’s preferred measures, grew by 0.7% through the quarter and rose 2.1% through the year to September 2021. This is the largest annual increase in the measure since 2015, though it still remains well within the RBA’s target band for inflation. 

Chart: CPI quarterly and annual change, %

Source: Australian Bureau of Statistics 

Within the CPI there is certainly evidence of tight supply chains and energy price rises. Automotive fuel experienced the sharpest rise, up 7.1% in the quarter. Fuel prices have now risen over 36% since the lows in March 2020, as the pandemic first hit Australian shores. Motor vehicles also experienced strong price growth, rising 1.4% in the quarter, and are now 8.7% higher than pre-COVID levels, largely due to supply constraints, COVID-related factory closures and elevated shipping costs. 

New dwelling purchases by owner-occupiers also jumped by 3.3% from the previous quarter, the largest quarterly rise since September 2000. Input costs for construction such as timber have surged recently following supply disruptions, and this, in conjunction with higher demand for building activity, has led to higher prices being passed on to consumers. Surprisingly, rents remained muted, growing a mere 0.2% through the September quarter. Rents rose strongly across most cities, but this was partially offset by falls in Sydney and Melbourne, down 0.5% and 0.3% respectively, with the absence of new migrants a factor in our two biggest cities. 

There were also other significant contributors in this quarter’s CPI, including audio, visual and computing equipment, which jumped 1.8%, and furniture, up 3.8%. These price increases may, in part, reflect the global semi-conductor shortage and supply constraints, colliding with still strong consumer demand for durables.

Conversely, prices for clothing and garments fell by 5.5% since June, with lockdowns leading to much higher than normal discounting.

Overall inflation concerns are spreading to financial markets. In the US in recent weeks, breakeven rates — the implicit inflation forecasts that can be generated by comparing inflation-linked and fixed yields on government bonds — have jumped sharply. The US five-year breakeven rate briefly eclipsed 3% for the first time in its two-decade history. 

US Federal Reserve Chairman, Jerome Powell, has since stated that these inflationary risks are clearly due to longer and more persistent bottlenecks. Such constraints are likely to keep inflation elevated for longer than previously expected which, in turn, could potentially put pressure on wages, which are a key factor in sustained inflation growth. Ultimately, Powell stated that if inflation was to remain persistently higher, the Federal Reserve has the tools to combat this – and he remained confident with the transitory narrative, whereby spikes in inflation are temporary. 

The RBA shares a similar view to its US counterpart, as most measures of longer-term inflation still remain relatively muted. This suggests that higher inflation is unlikely to persist without a sustained rise in wages. And despite skill shortages, that isn’t yet happening. 

Given this, the RBA has reaffirmed its guidance that the cash rate is expected to remain at 0.1% until at least 2024, although there may be less bond buying by the central bank, an additional measure that has been aimed at keeping borrowing rates low.