In a surprise, the Australian Bureau of Statistics revealed 1Q14 CPI growth of 0.6%, this being below economist expectations for an inflation rate of 0.8%.
Underlying CPI – which strips out volatile items like food, alcohol and tobacco – increased 0.5%, but missed estimates for a 0.7% rise.
On an annualised basis, headline inflation came in at 2.9% with underlying inflation running at 2.7%.
In the final quarter of 2013, headline inflation came in at 2.7% with core inflation running at 2.6%. Both measures were around the mid-point of the RBA’s 2% – 3% target band.
At the time of the December quarter inflation print, the Aussie economy was not firing on all cylinders. This was evidenced by the December employment figures, which revealed 23,000 jobs were lost during the final month of 2013.
Since then, however, the economy has shown clear signs of improvement, adding 84,300 jobs in the first three months of 2014.
The property market continues to be a key pillar of support for the economy. The rise in household values not only encourages consumers to spend but boosts demand for construction and related services.
Behind the numbers
These recent signs of economic improvement raised speculation of a big jump in inflation during the first quarter of 2014.
Although headline inflation of 2.9% was right at the upper limit of the RBA’s target range, underlying inflation was not.
Below is a graph showing the breakdown of the 1Q14 inflation rate. The left graph depicts each capital city’s contribution to CPI whilst the right graph shows CPI divided into its major categories.
In both graphs, each city/category is ranked top to bottom by the magnitude of its contribution to CPI.
As shown there was no major discrepancy in the inflation rates of the top three capital cities, highlighting the broad-based nature of the 1Q14 inflation read.
The second – and more important – graph reveals that the alcohol and tobacco categories were significant factors behind the March quarter inflation jump.
In particular, tobacco prices shot higher due to the federal excise tax rise from 1 December 2013. However tobacco is classed as a ‘volatile’ item and is given less consideration by the RBA when forming its view on monetary policy.
Seasonal factors were also responsible for the spike in healthcare and education costs. Education costs escalated during the quarter, but that was attributed to the commencement of the new school year.
Similarly, healthcare costs climbed but that was a result of fewer patients qualifying for subsidies under the Medicare Benefits Scheme and Pharmaceutical Benefits Scheme at the start of 2014.
Indeed other categories like clothing and footwear, and furnishing and household items, showed negative inflation during the quarter.
What it means
Today’s inflation result has hosed down speculation of the RBA adopting a tightening bias any time soon.
Core inflation of 2.7% ticked up from 2.6% the previous quarter, but still remains inside the central bank’s target band, illustrated below:
It’s also worth reiterating that seasonal and volatile categories were primarily responsible for the March quarter CPI jump.
RBA governor Glenn Stevens warned last month that despite the 4Q13 inflation spike, there weren’t persistent and serious inflation pressures building in the economy.
Once these transitory effects are cycled through this quarter, inflation is likely to drop if prices continue heading south in clothing, footwear and household goods.
The rising Aussie dollar appears to have contained pricing pressures in these categories. Retailers enjoying reduced import costs have less incentive to raise prices of their goods.
So it now appears the RBA will do what it has repeatedly said it would do – maintain a period of stability in interest rates.