First, some good news: the rate of inflation is falling. As the next chart shows, the headline rate has fallen from 7.8% in the last three months of last year to 7% in the first three months of 2023. So we are heading in the right direction.
But don’t expect that good news to turn into smiles down at the shops. The fall is small. Inflation is talked about like it’s a concrete thing we notice at the shops, but it is in fact very abstract. What we experience is prices. Inflation is just a measure of how fast prices rise.
In mathematical terms it is a first derivative — it measures the rate at which something changes. And when that first derivative gets smaller, when the rate of inflation changes from 7.8% per annum to 7%, it doesn’t put a spring in our step. What people will notice, actually, is that prices are still bloody going up, by 7%!
Now the bad news.
Inflation is changing its nature. At the beginning, it was all about goods, especially imported goods like fuel. But now goods prices are growing slower than expected or even falling. Instead, inflation has spread into services, especially non-tradeable services. That could be a bad sign — services are made here by Australian people, and high services inflation is a signal of wage inflation. To keep services inflation down the Reserve Bank (RBA) may yet have to push higher with interest rates.
The next two charts show goods v services and tradeables v non-tradeables. The pandemic was an unusual period where people couldn’t complain about cheap Chinese imports, because they weren’t cheap! But now normal service is resuming, with locally made non-tradeable goods like fresh bread growing in price quickly, and non-tradeable services (like haircuts) doing the same.
This suggests that inflation is not just something being imposed on us from abroad. It has spread its tendrils into the cracks in the Australian economy and is now putting down roots, which has to concern the RBA. The sole hope is that imported goods fall quickly enough in price to offset rising domestic prices and we can balance everything out with inflation back in the 2-3% range. It remains to be seen if that is realistic.
Another reason that the RBA might lift interest rates is rising house prices. The big banks were predicting house prices to fall this year, but in reality the bottom appears to be in and house prices are now heading up again, especially in the nation’s biggest market, Sydney. ANZ has changed its house price forecast to account for this, expecting price growth in the next eight months to compensate for price falls in the first four months, with the market ending the year flat.
For now, markets are not expecting further interest rate changes this year. Futures indicate the RBA will sit still with official rates at 3.6%. But if the price rises of Australian-made services continue to hold up, and if wages growth continues to drive them up, and if the housing market continues to warm up, the central bank will have no choice but to whack the whole economy with another round of rate rises and cool everything back down.
