To paraphrase a quote from the Reserve Bank's November meeting minutes released this week, "Australia is an exception". But we appear to be an exception - in one very important way. Australia's disinflationary path appears to be slower and more bumpy than in other jurisdictions around the world.
US core inflation is 4% but has come down significantly from the 6.3% figure recorded at the beginning of this year. In the EU, core inflation has declined from its intra-year peak of 5.7% to just 4.2%.
In Australia, core inflation on a quarterly basis has come down from 6.9% to 5.2%. 5.2% may be lower than price increases in recent times but it's still double the mid-point of the RBA's own inflation target. Last quarter's inflation report also demonstrated a tick higher in inflation. It wasn't a big tick higher - just 0.1% above the consensus economist expectation - but it was enough for rates markets to price at least one more hike (and possibly more) into the curve.
So why is Australia's disinflation problem different to other nations? And how many more rate hikes will we have to endure before we know that the inflation genie is back in its lamp for sure?
This exact question was the subject of Reserve Bank Governor Michele Bullock's address at last night's ABE Annual Dinner in Sydney. In this wire, we'll present her answer as well as some of the other key takeaways from that speech.
"I would like to focus on one particular consideration for policy: the remaining inflation challenge we are dealing with is increasingly homegrown and demand-driven."
Bullock made the case for why demand - services demand in particular - is responsible for a lot of the slow disinflation process we have in Australia.
While labour costs are a big part of the increase, huge increases in the cost of energy, rent, and insurance are all keeping inflation higher for longer. In the September inflation report, energy (utilities) prices increased more than 12% year-on-year and insurance premia increased more than 8% year-on-year.
"If inflation is simply the product of global supply disruptions or other price rises that monetary policy has little influence over then the appropriate response from interest rates would generally be limited."
In highlighting the role elevated demand plays on inflation, she also highlighted the role that supply-side factors had on our earlier inflation experience. Central banks cannot control what supply-side shocks occur and when.
For example, they cannot control what the oil price will do when conflict breaks out in the Middle East and how that may flow through to petrol prices.
But when supply-side shocks ease and inflation remains high, then central banks can work out that demand is the main driver of price increases. This is why the RBA raised interest rates at its November meeting, and why there is still a risk it can raise rates into early 2024. And as we found out last night, interest rates really are the only main tool the Bank has at its disposal in curbing demand. So if inflation remains this demand-driven and this high, you can bet more rate rises are coming.
"An important implication of this homegrown and demand-driven component to inflation is that getting inflation back to target will take time. It took only three quarters for inflation to fall from 8% to 5.5% as the supply-side issues eased, and there is some more to go there. But we expect it to take another two years for inflation to fall that much again and move below 3%," Bullock said last night.
Finally, she put her foot down on the rate hike debate. While she acknowledged that rate hikes hurt households and that her message would likely not be welcome, she didn't exactly mince her words.
"I receive letters from people who are finding it difficult to make ends meet and I speak with organisations that assist struggling households. I also know that interest rate rises are squeezing the finances of households with a mortgage. But while the Board recognises there is a wide diversity of experience, the Bank’s statutory objectives are economy-wide outcomes, and our key tool – the interest rate – is a blunt one. The Board must therefore set its policy to serve the welfare of Australians collectively," she said.
For economists, that's as hawkish as it gets. For everyone else, ouch.
One lesson we learn as economics reporters at events like this is that the best parts of a story often come in the Q&A session that follows the official speech. Here are some of the other highlights from that portion of the evening.
Livewire: What other tools do you have at your disposal that you can use to bring demand down and inflation faster than the current end-of-2025 forecast in the Statement on Monetary Policy?
Bullock: Well, we've only got one instrument and that's the interest rate. Some people talk about QT (quantitative tightening) but if you look at our analysis of our quantitative easing program, the impact is pretty marginal.
So really, we've only got one instrument and I think every central bank pretty much has that.
But I think that's why the RBA Review mentioned that we need to be working and making sure that fiscal policy and monetary policy are working together in the same direction. The Treasurer has made comments on that. And certainly, I think that's one major focus going forward: How do we, when the government is independent in setting theirs [fiscal policy], [and] we're independent, setting our [monetary] policy. But how do we work together to make sure that we're working in the same direction.
Commonwealth Bank chief economist Stephen Halmarick: Where are the bottlenecks in the residential property construction sector and what can be done about them?
Bullock: So what we're hearing in liaison is that the pipeline of residential work is still running off because it's experience labour and material shortages is still running off. But actually, there's not much left after the pipeline finishes. The other thing we're hearing about is that there is contention for resources from infrastructure.
So, we do have a bit of an issue in Australia with being able to build housing and certainly the targets set by the government. It's great that they're focusing on it, but they're much higher targets than we've ever managed to hit before. So it's no easy answer.
The residential property and national housing target debate were a key feature of the recent episode of Signal or Noise, which you can view here.
Barrenjoey senior economist Johnathan McMenamin: What impact has increased migration had on your mission to bring inflation back down to target?
Bullock: A lot of people have made quite a [big] deal about the fact that capital consumption is declining, but aggregate consumption is still arising obviously and slowly. What people often don't realise, or maybe forget, is that the increased population also adds to supply.
I think our judgment is that yes, there is, there is a bit of adding to inflation pressures from demand. But at the same time, the increase in the population is adding to supply of labour and that's helping on the demand side and the balance in the labour market as well.
So it's not clear cut that immigration is just simply causing a lot of inflation. You can point to housing and rents as being one particular area where there's a particular bottleneck. But I think it's a tougher argument than that.
I think we would argue and I think we've probably said it in our Statement on Monetary Policy that actually if you take into account what it's doing on the supply side, it's not clear that it's adding heaps to inflation pressures.
Livewire is making a concerted effort to be more present at events and speaking opportunities. The ABE Dinner was one such event. But "dinner" may be a stretch for what the media table was given - sandwiches and a bottle of wine.
Now, for full disclosure, the economists in the room pay good money to be guests at the event and one of the questioners (Barrenjoey) actually sponsored the event. But for the economists to be fed a three course dinner while the journalists get sandwiches was perhaps an accidental oversight. That, or the ABE is showing us in the media what a hard landing looks like.
And regardless of whether we get dinner or not, we stress that Livewire is grateful to be invited to these events to ask questions of our economic leaders.
Originally published on Livewire Markets.
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