25
Jan
2012

>Inflation is a Dead Duck

>

The CPI recorded zero change in the December quarter locking in a marked deceleration in inflation through the course of 2011.  In the last six months, headline inflation has run at an annualized pace of 1.3%, with some of the deceleration due to a reversal of the price spikes for goods and services impacted by the floods and cyclones early in 2011.
The RBA measures of underlying inflation (which strip away some of the price impact from adverse weather) rose 0.6% in the December quarter after rising 0.4% in the September quarter to be 2.6% above the level of a year earlier.  This continues the run of inflation results at the mid-point of the RBA target.  The RBA has delivered underlying inflation at 2 ½% for the last 18 months.
Well done team!
But in the last two quarters, the underlying inflation rate has increased at an annual pace of just 1.9% – below the bottom of the RBA target and the lowest six month reading (as far as I can calculate with available spreadsheets) since 1998 and is equal to the second lowest six month result since the early 1980s (which is as far back as the history of the underlying inflation measure goes).  I am checking this and will amend if revisions have changed this calculation.
On this measure, inflation is a dead duck.
Thankfully interest rate cuts have started with this disinflationary pressure and with this result, more will be delivered.
With the economy muddling along for the last 3 years, with never once in that time GDP growth rising above 3.0%, it should be no surprise that inflation is so low.  There’s growing capacity in the economy.  What’s more, the labour market is shedding jobs, asset prices are falling with houses and stock prices lower; fiscal policy is tight and the global outlook is shaky. 
The inflation results suggest the RBA is all but certain to deliver an interest rate cut at its 7 February Board meeting with the event and data flow between now and then determining whether the current thinking of a 25 basis point cut will need to be super-sized to a 50 point move.
Global economic conditions may tilt discussion towards a 50 point move, as will the bank funding cost pressures starting to hit the banking sector.  The mining boom, the still high terms of trade and business investment explosion suggest the RBA should cut 25 points only.
The local news between now and the RBA Board meeting on house prices, monthly inflation, retail sales and building approvals will all figure in the discussion.  At the moment, the odds favour a 25 point cut, but stay tuned.

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