Today’s inflation figures showed inflation pressures have eased, just a day after the Reserve Bank of Australia (RBA) warned inflation was still too high.
The Australian Bureau of Statistics reported the consumer price index (CPI) rose 3.8% in the year to June, down from 4.0% in the year to May. The RBA’s preferred measure of underlying inflation, the trimmed mean, was steady at 3.6%.
(The trimmed mean shows core inflation after excluding or “trimming” away the items with the largest price rises or falls, leaving the weighted average of the middle 70% of items.)
This is the most important piece of domestic economic data the RBA will receive before its next interest rates meeting on August 10–11.
Financial markets cut the chances of a rate rise next month to close to zero after the softer-than-expected inflation report. But there is still a meaningful chance of one more rate rise later in the year if inflation risks rise.
How the picture has changed since June
The largest contributors to annual inflation were housing (up 6.8% in the year), food and non-alcoholic beverages, and transport. The largest monthly decline was in automotive fuel prices in June, as global oil prices fell.
Services inflation remained persistent, particularly in housing-related categories such as rents. This suggests underlying domestic price pressures have not fully subsided.
Although inflation moderated in June, slightly below the RBA’s forecasts, it remains well above the central bank’s 2–3% target.
However, the world has changed since June.
This month, a renewed escalation in the conflict in Iran sent oil prices back above US$100 a barrel, although they have eased again this week. This has created fresh inflation risks that are not reflected in the June report. The June CPI tells us where inflation was. The RBA must decide where inflation is heading.
Last week’s employment figures reinforced the complexity of the RBA’s task. Employment rose by a stronger-than-expected 76,300 in June. The figures suggest labour market conditions remain resilient, giving the RBA scope to focus on inflation risks.
Australia’s inflation problem has changed markedly over the past two years.
The broad-based inflation that followed the pandemic has eased as supply chains recovered and higher interest rates slowed demand. While trimmed mean inflation remained at 3.6% in June, it was considerably lower than the post-pandemic peak of 6.8% in December 2022.
Remaining price pressures are concentrated in services such as rents, insurance and healthcare, where inflation has proved more persistent.
Why higher oil prices remain a threat
Looking ahead, global energy markets have been shifting dramatically in recent weeks, with oil briefly surging back above US$100 a barrel.
Higher oil prices do far more than increase the cost of filling up the car. They raise transport, freight and production costs throughout the economy. Businesses eventually pass some of those higher costs on to consumers, placing renewed upward pressure on inflation.
Australia is less vulnerable to oil shocks than it once was, but sustained oil prices above US$100 would still complicate the inflation outlook. Unlike demand-driven inflation, this is a supply shock that interest rates cannot directly offset.
Close to the RBA’s worst-case scenario?
A sustained oil price near US$100 is remarkably close to the scenario the RBA has been warning about, with inflation still tracking above the RBA’s 2–3% target.
The RBA has already raised the cash rate three times this year — in February, March and May — as it sought to return inflation to target.
On Tuesday, RBA Governor Michele Bullock warned the bank was “prepared to act as required” to get inflation under control, including by increasing the cash rate further.
When the RBA raises interest rates, it slows economic growth and helps bring down inflation. Bullock’s comments suggest the RBA remains prepared to raise rates further if new inflationary pressures emerge.
She made clear the RBA is not simply assessing today’s inflation numbers. It is assessing the risks to inflation over the months ahead.
If higher oil prices prove temporary, the RBA is likely to look through the direct effect on inflation. The greater concern is that higher energy costs begin feeding into transport charges, business costs, wages and inflation expectations, making inflation more persistent and more difficult to bring back to target.
What happens next?
Today’s CPI figures confirm inflation was continuing to move in the right direction through June. But because the figures predate the recent surge in oil prices, they are unlikely to settle the policy debate on their own.
When the RBA meets on August 10–11, it will weigh evidence that inflation was continuing to ease against the risk it might prove short-lived.
Whether another interest rate increase becomes necessary will depend on how persistent the oil shock proves to be – and whether businesses pass higher energy costs on to consumers.
The RBA’s challenge is no longer understanding where inflation stood in June. It is judging where inflation is likely to be over the months ahead.
This article was originally published on The Conversation. Read the original article.
