Not long ago, I wrote a post arguing why I thought GDP growth was too low. I outlined several reasons in support of this argument: 1) that the pool of unemployed persons has been growing for a duration similar to that of the early 90’s recession and 2) real income per capita was no longer growing. The recent release of Q3 2014 CPI data provides some further evidence supporting this argument. Where aggregate demand is growing faster than its potential rate, demand for resources generally places upward pressure on prices and unemployment declines. The release of Q3 CPI shows that consumer price growth in Australia has started to slow, with growth of core inflation now in the middle of the RBA range of between 2 and 3%. Over the last few quarters, annual CPI growth was at the upper end of the RBA band which seemed at odds with the idea that growth in Australia was too low. There were in fact suggestions that the RBA would need to hike rates. But quarterly CPI growth and other price measures such as wages, commodity prices and Terms of Trade (ToT) have been pointing to an easing in the level of price growth across the economy. Whilst a rate of core CPI right in the middle of the RBA range doesn’t sound like a problem, it’s in combination with indicators such as unemployment growth and income stagnation that point to this as another symptom of a bigger/broader issue.
This situation is not limited to Australia. Globally, price pressures have been easing, with growing concerns of emerging deflation throughout Europe, US, UK and China according to data recently published by The Economist (25th Oct 2014). It’s difficult to pinpoint just one reason for this phenomenon, but slowing global growth is a good starting point. For Australia, the reversal of the ToT boom has been a fairly significant factor associated with slower income growth, growing unemployment and now slowing price growth.
Highlights of CPI Quarter 3 2014
The Sept quarter CPI growth was 0.5%, the same rate of growth in the previous quarter. Quarterly growth at 0.5% is just below the average for Sept CPI growth over the last 10 years of +0.8%.
The quarterly growth trend has been slowing throughout the last four quarters:-
The annual rate of growth slowed significantly in the Sept quarter from 3% to 2.2% (seasonally adjusted). This large slow-down in annual growth is partly the result of the shift to a higher base used to calculate growth – Sept 2013 quarterly growth was relatively strong at +1.2% (see chart above). That said, the quarterly growth since Sept 13 has been slowing, resulting in annual CPI growth closer to 2% – at the lower end of the RBA range – and reaching this point in a relatively short period of time.
The measures of core CPI growth provide a better guide as to the underlying price growth. Growth in measures of ‘core’ CPI, the trimmed mean and weighted median, eased somewhat in Sept and remain in the middle of the RBA range. The trimmed mean view of consumer prices is the main focus for RBA assessment.
For the Sep 2014 qtr;
- Trimmed mean (15% of the smallest & largest price movements are removed or ‘trimmed’) +0.4% quarter on quarter and +2.5% year on year (a slowing of the annual rate)
- Weighted median (price change at the 50% percentile by weight of the distribution of price changes) +0.6% quarter on quarter and +2.6% year on year (no change in the annual rate)
The biggest contributors to quarterly CPI growth was in Food and Housing categories:-
The biggest price pressures under Housing were Purchase of New Dwellings and Property Rates and Charges. Both offset the large -0.14 % pts decline in Utilities (Electricity) that also fall under this category.
There was one single significant contribution to growth in Food CPI and that was in the Fruit category.
The big turnaround for the quarter was the slow-down in Health costs, from +0.17% pts last quarter to -0.1% pts this quarter.
Overall, CPI growth is slowing, but for the most part is sitting right in the middle of the RBA range. Based on this, it’s unlikely that there will be pressure to raise rates.
But there is a broader context to this CPI report…
Back in Sept 2012, Assistant RBA Governor, Christopher Kent, gave a speech to the Structural Change and the Rise of Asia Conference titled Implications for the Australian Economy of Strong Growth in Asia. This speech laid out the broad set of factors effecting the Australian economy, namely the impact of economic growth in Asia (China) on driving our Mining boom. The most visible impacts in Australia were the rise in the ToT, an appreciating exchange rate and the growth or “reallocation of productive factors” to resources and resources related industries.
It’s relevant to revisit some of the points of this speech as they relate to the impact on prices and growth now that the positive ‘shock’ to the ToT has started to reverse and the economy has commenced the transition from phase II (investment) to phase III (production and export) of the boom.
“The positive shock to the terms of trade, resulting from a rise in commodity prices, increases income accruing to the resource sector and increases that sector’s demand for productive inputs. Both of these exert a measure of inflationary pressure.” Christopher Kent, RBA Assistant Governor, 19th Sept 2012
“Domestic inflationary pressures, associated with higher wages and incomes, will lead to higher inflation for non-tradable goods and services but, at the same time, the gradual pass through of the initial exchange rate appreciation will lead to lower inflation for tradable goods and services (whose prices in foreign currency terms depend to a significant extent on global considerations). In this way, the appreciation of the exchange rate helps to offset the inflationary impulse from the terms of trade shock, and assists in maintaining inflation in line with the inflation target.” Christopher Kent, RBA Assistant Governor, 19th Sept 2012
We’ve seen all of this happen in the Australian economy.
Firstly, the rise in the ToT generated higher income growth.
Once the ToT started to appreciate, real GDI started to grow much faster than real GDP – the difference being the impact of the ToT. The ToT peaked during Sept qtr 2011 and is now 21% below that peak. While the ToT did peak, it is still well above its historical levels for the moment – but income growth has stalled nonetheless. More on this later.
Secondly, the exchange rate did appreciate during the investment phase of the boom.
The real AUD TWI appreciated during the years between 2000 and 2011, with the exception of 2008/9 (GFC). Growth in the exchange rate started to slow from June 2011 but importantly, remained elevated until it peaked in March 2013. Since then, the real AUD TWI has fallen by 7%.
Finally, there was greater inflationary pressure in the non-tradable sector than the tradable sector (see definitions and detail of each here) during the period of the investment phase of the Mining boom.
It’s hard to look at this chart and ascertain a ‘neat’ relationship between exchange rate changes and annual tradable inflation. The range for tradable CPI growth has been between +4% and -2% during this time, but has generally been lower than non-tradable inflation growth. This can be shown more clearly by reproducing one of the charts from the RBA speech – the ratio of non-tradable CPI to tradable CPI.
This first chart is from the RBA speech as it provides the historical context. The second chart is updated using the latest data (with as much history as available from the ABS).
This first chart reinforces that since the start of the ToT boom, non-tradable inflation has grown much faster than tradable.
The updated data show a fairly important change in that trend – non-tradable CPI growth started to slow from March 2013:-
Source: ABS, The Macroeconomic Project
This is an unusually long period of no change in this ratio, given the growth in non-tradable CPI during recent history. Prices are still growing, but at a slower rate and this is could be an important indicator of slower demand in the domestic economy.
Since June 2013, non-tradable CPI has started to contribute less to total CPI growth. In Sept 2014, non-tradable CPI made its lowest contribution to total CPI growth (contribution data is only available back to June 2012). Since June 2012, tradable CPI also started to have an increasingly positive contribution to CPI growth, but it too made a smaller contribution to CPI growth in the recent quarter. Both tradable and non-tradable CPI slowed in the latest quarter:-
There are 47 categories classified as ‘tradable’ – which contributed +0.76% pts to CPI growth. In over half of those categories (26), prices are either flat or declining (YoY -0.39% pts), 17 categories contributed +0.31% pts and the top 4 categories contributed the bulk of the price growth +0.86% pts. The categories were Tobacco, Fruit, Vegetables and International Holiday & Travel. The increase in Tobacco prices is due to an excise increase.
By contrast, there are 40 categories classified as non-tradable, which contributed 1.58% pts to overall CPI growth. In only 12 out of 40 categories are prices flat or declining, contributing -0.26% pts to overall growth. The bulk of the growth in non-tradable CPI comes from the ‘middle’ 24 categories which contributed +0.94% pts. The top 4 non-tradable categories still punched above their weight adding +0.87% pts. The top 4 categories are (in order) Purchase of New Dwellings, Medical & Hospital Services, Rents and Other Services in respect of Motor Vehicles.
There is broader pressure i.e. more categories contributing to CPI growth, in the non-tradable sector and our housing market (new dwellings anyway) is driving one of the biggest parts of that growth.
This brings us to the present day – and we are now seeing the opposite effects take place as the ToT boom reverses.
As mentioned earlier, the ToT has declined by 21% from its peak and the most important thing about this in relation to the CPI is the impact on income growth. The most accurate representation of the income effect is to look at Real Net National Disposable Income (NNDI) per capita. During the ToT boom (2000-2011), growth averaged 2.9% (not including the GFC). Since the ToT peaked in Sept 2011, income growth has averaged 0%.
In per capita dollar terms, real NNDI has declined by -2.6% since its peak in Sept 2011 (ToT peaked at the same time). This isn’t a huge drop (the chart above measures growth not the per capita value) and the decline is not a short and deep correction that you would see associated with a recession, but rather, income growth has stagnated (at best) over a somewhat extended period of time. Unfortunately, further declines in commodity prices are expected and this is likely to maintain pressure on income growth. If National income growth remains low, it’s likely that CPI growth, especially non-tradable CPI, will continue to slow.
Unfortunately, the exchange rate stayed high during the initial falls in commodity prices and the ToT (the ToT started falling from Sept 2011 and the real AUD TWI only started to decline from March 2013). Elsewhere in the economy, it’s likely that the final stages of the Mining investment phase, a continued housing boom (which requires some funding from overseas markets to maintain loan growth) and relatively higher interest rates in Australia since the GFC have kept the exchange rate higher than expected. This has placed some local non-resources industries and the resources sector (due to falling commodity prices and the scramble to cut costs) at a disadvantage. So far the real AUD TWI has only fallen by 7% and the AUD/USD has fallen by 20% but remains above the level that the RBA deems as its ‘magic spot’ of between US$0.80 and US$0.85 (SMH, “IMF: Australian dollar should trade at ‘low US80¢'” 25-27 Jan 2014).
This is not a recessionary period and total output has not declined, but activity/growth has slowed. For the moment, income growth per capita has stopped, unemployment continues to rise and price pressures are starting to ease in the domestic economy as our ToT boom reverses and global growth remains low. This situation is likely to continue, if not become worse, as further falls in our ToT are expected. From a policy perspective, it’s unlikely, given this environment, that the RBA will increase interest rates in the short-term. Depending on the size/severity of changes in the ToT, it would be more likely that the next move in the official cash rate will be down.
The huge elephant in the room remains the ongoing strength of the Australian housing market.