It has been well documented that the carbon price will add around 0.7% to the rate of inflation as measured by the consumer price index, with the main addition to household costs being through a 10% rise in electricity prices. These price effects, while relatively small, will be a dominant issue in the political and policy discussion on the price on carbon.
A big positive unfolding for the Government just as the carbon price comes into force is a large drop in petrol prices.
Recent trends in global oil markets has seen petrol prices fall sharply, by an average of around 13% since a peak was reached at the end of April. While global oil prices have picked up a touch in the past week, petrol prices will hover about 10% below the April peak for the next few weeks at least.
In terms of the timing and the order of magnitude, the petrol price fall is manna from heaven for the Government.
It is not widely known or commonly understood just how little of the household budget is spent on electricity. The perception is that electricity makes up a large share of the household budget. According to the weights used by the Australian Bureau of Statistics in calculating the CPI, electricity accounts for just 2.2% of the household budget. As an aside and by way of comparison, 4.8% of the household budget is spent on alcohol.
Petrol, on the other hand, accounts for 3.6% of the household budget based on the weights in the CPI, making petrol price falls significantly more important to cost of living than the rise in electricity. The average household is saving roughly 60% more via lower petrol prices than they will be paying via higher electricity prices.
In other words, the recent 10% fall in petrol prices, if sustained, will directly cut around 0.4 percentage points from the CPI. Indirectly, the effect will be a little larger as transport and other costs influenced by petrol prices either fall or are kept in check.
These facts show that the overall cost of living impact from the implementation of the carbon prices will fortuitously be more or less completely offset by the recent fall in petrol prices. If account is then taken of the household compensation by way of income tax cuts and pension increases, the cash position of the household sector will materially improve as the carbon price comes in and as petrol prices edge lower.
From a cost of living or well-being perspective, it should also be noted that the levy on middle to high income earners to pay for part of the repair bill for the Queensland floods ended on 30 June 2012. The ending of this levy will provide yet a further boost in take home pay, which in turn will further add to the disposable income of the household sector.
The story of the improving finances of the household sector does not end there. Mortgage interest rates have fallen by around one percentage point since November 2011 which for highly indebted consumers, presents a significant boost to cash flows.
The petrol price may not stay low for long. Its price is a function of the global economic activity and the level of the Australian dollar. For now, it appears that global economic activity will remain subdued at least until the end of 2012. At the same time, the Australian dollar appears to be very resilient, buoyed by the triple-A rating that attracts safe haven capital inflows, and relatively high interest rates, a point compounded in international markets where other safe haven countries have interest rates near zero.
These factors suggest that global oil prices and hence petrol prices in Australia are likely to remain well contained, at least for the next few months. The government would be wise to make these points when talking about cost of living issues as the carbon price starts to push a few other prices a little bit higher.