Why interest rates are defying Australian economists' inflation delusion | Greg Jericho

The latest low inflation growth figures, even with soaring electricity prices, suggest interest rates will be stable for some time

One of the oddest things about Australian economics is the market’s continuing desire to believe inflation growth is going to come sooner rather than later and that, as a result, interest rates will also begin to rise. And yet time and time again, the inflation figures disappoint them. The latest low inflation growth figures – even with soaring electricity prices – suggest interest rates will remain stable for some time to come.

Last week was a classic demonstration of just how weakly inflation is growing. The September quarterly growth figures were an unusually solid 0.6% – the third strongest in four years – and yet the annual inflation growth of 1.9% remained below the RBA’s target range of 2%:

It meant that money market investors (or speculators if you want to be less generous) were again revising their predictions of when interest rates would next rise.

A month ago the market was fully pricing in a rise in the cash rate to 1.75% by next August; now it is barely 50% sure that such an event will occur:

How would you like to have your financial adviser to tell you they have an absolute sure thing, only for a month later to come back to you and say, “So about that sure thing, turns out it’s a coin toss”?

When we break down the inflation growth into tradables (items of which the price is mostly influenced by the world market) and non-tradabales (items like rents, childcare, education, property rates) we see that the price of our imports and goods affected by international prices fell, while the prices of non-tradables rose strongly – up 3.2%, the highest it has been for three years:

Now in times past that might have been a sign that interest rates were about to rise – as that can be a sign that the local economy is heating up, and the RBA might be worried that inflation is about to jump.

But the reason for the strong rise in non-tradable items wasn’t that the economy is going gangbusters. Rather it was because of one of the biggest political hot potatoes going around – electricity and gas prices.

The ABS noted that the average price of electricity across the country rose 8.9% in the September quarter and gas prices rose 5.2%. It means that both are now more than 10% higher than they were when the carbon price was rescinded in July 2014 – well ahead of overall inflation:

But the rises are not uniform – Adelaide and Sydney have the biggest jumps in electricity prices, while Canberra takes the lead in gas price rises:

And, as the ABS noted, it was due to rises in wholesale prices, rather than as a result of jumps in retail prices reflecting strong increases in demand. In effect, the price rises had nothing to do with the strength or lack thereof in the economy.

It means the RBA’s measures of underlying inflation remain pitifully low.

Both the trimmed mean and the weighted median grew in the past 12 months by less than 2% – making it nearly two years that underlying inflation has been below the RBA’s target band:

It would fairly stretch credibility to think that the Reserve Bank would be thinking of raising interest rates in such a situation and yet the market continues to believe that stronger inflation growth must be just around the corner.

The continuing low inflation also impacts on wages. Generally wages are “sticky” ie they are slow at moving to changes in the economy. And with inflation being low for so long now, it is likely that even should inflation begin to rise it will take some time for wages to follow suit.

The inflation expectations of union leaders remain very low over the next year, with some hopes for improvement to a more average growth of 2.5% over the next two years:

It suggests wages growth will remain relatively weak, even in spite of improved employment, and that the interest rates rises the market keeps predicting might also have to wait a bit longer as well.


Greg Jericho

The GuardianTramp

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