Inflation: no threat yet

Today’s Consumer Price Index (CPI) release for the March 2021 quarter saw headline inflation rise: CPI increased by 0.6% this quarter, with annual inflation rising 1.1% (up from an annual increase of 0.9% in the December 2020 quarter).

This takes Australia approximately back to pre-COVID quarterly changes in CPI, as we start to move past the bounce-back in inflation seen in September and December of 2020. Key measures of underlying inflation have stayed subdued: the trimmed mean inflation rate rose by 1.1% which was the lowest annual movement on record (though still close to the 1.2% rise we saw in December).

So, at this stage the economic recovery is far from springing an inflationary surge.

Chart: CPI quarterly and annual change, %

Source: Australian Bureau of Statistics
The most significant rise this quarter was in fuel prices, which were up 8.7% since December. Volatile fuel prices have been a defining driver of inflation throughout COVID. Nearly half of the record 1.9% quarterly fall in the June 2020 CPI figures came from a 20% fall in fuel prices (as the world grappled with widespread lockdowns). This quarter, they rose 1.7% in January, 2.7% in February and 7.0% in March – reflecting both recovery in world oil prices and lifting consumer confidence and travel in Australia. A similar consumer confidence story can be seen in rising prices for accessories (up 7.3%), as consumers begin to indulge more in discretionary spending.

Other significant contributors to this quarter’s CPI were healthcare (particularly through a 5.3% rise for pharmaceutical products and a 1.5% rise in medical and hospital services). Government supports have also played a role in offsetting inflation. The ABS noted that the measured fall in new dwelling prices was due to the impact of various  government grants (notably HomeBuilder) offsetting the rising cost of building, where otherwise new dwellings prices would have risen this quarter. Similarly, the federal Job-ready graduates package has resulted in falling education fees.

Market expectations had actually been for a higher CPI increase this quarter, given the emergence of pockets of strong demand. It is important to remember that a sustained lift in inflation requires a multitude of factors to align. Inflation is not a threat to markets and investors yet – it will take time and more significant consumer spending to really see inflation spike. So far price changes still largely reflect economic recovery, rather than significant expansion.

Demand has some way to go to catch up to supply. For inflation to really lift, unemployment and underemployment have to fall enough to give pricing power to workers and businesses, and in particular consumers need to see wage growth to be able to drive demand, and prices, upward. Though we’ve seen more positive outlooks around unemployment in Australia, there is still some way to go for the labour market recovery to result in wage growth (which was slow even before COVID). Without wage growth, we shouldn’t expect prices to rise rapidly anytime soon.

As all measures of inflation (particularly underlying inflation) are well below the Reserve Bank’s inflation target of 2 to 3%, the expansionary agenda of both the Reserve Bank and governments looks set to continue.