The latest inflation figures released by the Australian Bureau of Statistics look, at first glance, like good news. The headline rate for May rose 4.0% over the past year, down from 4.2% in April.
After a long run of high inflation numbers and interest rate hikes, mortgage holders could be forgiven for hoping rate relief is on the way.
But don’t hold your breath. Look under the bonnet and the picture is far less comforting. The fall was largely driven by one thing — petrol — and the part of inflation the Reserve Bank of Australia (RBA) actually cares about hasn’t budged.
Why inflation matters
Inflation is measured by the consumer price index (CPI), which tracks the price of a typical basket of things Australian households buy.
The RBA has one main job here: keep inflation low and steady at around 2.5% on an annual basis. Its main tool is the cash rate, the official interest rate that flows through to your mortgage and your savings account. When inflation runs hot, the bank lifts that rate to cool spending down.
Fuel is the great troublemaker in these figures. Back in March, petrol prices jumped almost 33% in a single month after the Iran war squeezed global oil supplies.
Since then, two things have pushed oil prices down sharply: a tentative peace deal has let global oil prices fall, and the federal government’s decision to halve the fuel excise — the tax charged on every litre — is still keeping prices at the pump down.
Cutting through the noise
Cheaper petrol drags the headline number down; headline CPI actually fell 0.1% in the month. But it doesn’t tell us anything about whether the broader economy is cooling. It just tells us oil got cheaper.
Because petrol prices swing wildly, economists watch a steadier measure called underlying inflation, or the “trimmed mean”. This cuts out the biggest price rises and falls and shows what is left in the middle. Think of it as ignoring the loudest person in the room so you can hear what everyone else is saying.
And once you ignore the petrol, the room is still too noisy. Underlying inflation came in at 3.6% in May, up from 3.4% last month and still far above the RBA’s target.
Two kinds of price pressures
Economists often divide inflation into two types.
The first is “tradeables”: goods bought and sold around the world, like petrol, phones, televisions and cars. Their prices are largely set overseas. There’s not much the RBA can do about the global oil price, up or down.
The second is “non-tradeables”: things produced and used right here, like rent, a restaurant meal, a plumber’s call-out, a dentist’s appointment or school fees. Their prices depend on local demand and local wages.
The cheaper petrol that improved this month’s headline sits in the first bucket. The inflation that refuses to fade sits in the second. Rents (up 3.6%), insurance (up 5.5%), health (up 3.8%), education (up 4.8%) and eating out (up 4.0%) are still rising strongly.
That pressure is not being imported. It is homegrown, and it is being driven by Australians who are still willing and able to spend.
When inflation falls because of a global price move — cheaper oil, say — the RBA usually looks straight through it.
But when inflation stays high because of strong local demand, that is exactly the problem interest rates are built to fix. Higher rates leave households with less to spend, so demand cools and price pressures ease. A domestic inflation problem has a domestic solution — and a temporary discount on petrol does nothing to solve it.
Dean Lewins/AAP
This homegrown, services-driven inflation is also the kind the RBA watches most closely, even when it doesn’t say so out loud.
So a lower headline like today’s is not the green light for rate cuts that some will read it as. If anything, strong underlying inflation keeps another rate rise on the table.
Read more:
The RBA holds interest rates steady, but warns another hike is possible if inflation stays high
Homegrown inflation is the concern
There is a sting in the tail. The petrol relief is temporary on both fronts. Global oil prices can turn again in a week. And the fuel excise cut was always meant to be short-lived — and it is now being wound back. This will push prices at the pump back up over the next month or two.
When that happens, the headline figure will bounce straight back up. The “good news” in today’s number will evaporate.
The only measure that will have told a consistent story throughout is the underlying one — and it has been flashing the same warning all along.
Last week, the RBA held the cash rate at 4.35%, after lifting it three times already this year. But it warned it stood ready to move again if inflation stayed high.
Soft headline inflation driven by cheap petrol is not the kind of sustained progress the RBA is looking for. My own cash rate tracker shows financial markets are not betting on relief any time soon.
Because when inflation is being made at home, a cheaper tank of imported petrol doesn’t change the cure.
