To curb inflation, Australian governments should delay some of their own spending | Cherelle Murphy
The inflation story in Australia has a new chapter and it is unlikely to have a happy ending for bondholders.
A surprise rise in the core inflation measure favored by the Reserve Bank of Australia last week is likely to be met by more rate hikes, even as overseas talk has been dominated by inflation starting to calm.
The 25 basis point rate hike likely to be delivered on February 7, and likely to be followed by another on March 7, will do nothing to reverse the 6.9% rise in core inflation in the year to the December quarter last year not recovered, what will be. at the center of the RBA’s concerns. But this will (hopefully) prevent inflation from sitting so high above the RBA’s target band of 2% to 3% later this year.
We will hear more about the RBA’s intention to get inflation from its head of economic analysis, Marion Kohler, and deputy, Tom Rosewall, when they appear before the parliamentary select committee on the cost of living on Wednesday.
At the moment it is useful to think about inflation for goods separately from inflation for services.
In the year to the December quarter, goods inflation rose by 9.5% while services inflation rose by 5.5%. But the contribution of the change in services inflation to the change in the consumer price index over the December quarter was 1.2 index points. This compares with the goods contribution of slightly less at 1.16.
This implies that while goods inflation is very high, the RBA is likely to be less concerned about its trajectory in 2023 than services inflation.
The rise in the cost of goods during Covid-19 lockdowns – as we built and renovated homes, went on bike rides and picnics – is probably past its peak.
Goods inflation rose 1.6% in the December quarter, but this followed quarterly changes of 2.1%, 2.6% and 2.9%. That doesn’t mean prices have fallen, they’ve just risen a fraction less quickly.
Governments do not need to add fiscal stimulus and work at cross-purposes with the RBA
The 2.1% rise in service prices in the December quarter may have only just begun. This was an acceleration in price growth from the 1.1%, 0.6%, 1.6% growth rates in the previous three quarters.
Services are in high demand as we return to more normal consumption patterns, with some added oomph because we missed so many of them during lockdowns.
They also go up in price quickly because they are supplied by people, and keeping good workers and recruiting new ones is expensive. The unemployment rate is not far from a near 50-year low, and job ads indicate that there are about as many jobs being advertised as there are unemployed people.
One measure, “compensation of employees”, tells us about the wage and salary bill across the economy and includes wage increases due to job changes and promotions. It was up 10% in the year to the September quarter.
We’ll get a very important update on that number for the December quarter in early March. I suspect it will show solid growth.
There are fresh wage demands from unions trying to protect their members’ living standards.
And civil servants protest. Their annual wages have now grown more slowly than those in the private sector for seven consecutive quarters.
The RBA will be most aware of wages as it formulates its inflation forecasts, which inform its interest rate decisions. The RBA governor made himself unpopular (again) late last year when he said he did not want to see wages rise too quickly.
Is there anything else that can be done to turn this story around and lead to a happier ending?
The government looks set to offer households some energy price relief in the May Budget. But this is a short-term solution at best and not useful in the long run. It’s market intervention that the government will only reluctantly and temporarily provide because it could distort energy consumption patterns, as well as future investment plans.
A more sensible solution would be for governments – commonwealth and state – to take pressure off the economy (and the RBA) by slowing their own spending. This will be difficult, especially given the demands of civil servants for salary increases. But together, governments are responsible for more than 27% of GDP. It is well above average and poorly timed.
In building massive infrastructure projects, state governments demand many of the same workers that the private sector does. Governments do not need to add fiscal stimulus and work at cross-purposes with the RBA.
Temporarily rolling back spending is not simple and requires national coordination. But it’s a challenge worth taking to ensure interest rate rises don’t hurt the economy.
It is a chapter that both the RBA governor and the treasurer would rather not write.
Cherelle Murphy is Chief Economist at EY Oceania