Dropping into deflation as CPI Index falls

This week’s readings include lessons from Australia’s government debt market during COVID-19, several reviews of this week’s Australia-United States Ministerial Consultations (AUSMIN), an argument that government bailouts and easy money are ruining capitalism, as well as an opposing case for the defence (well, for central banks anyway), a debate on forecasting, probability and the pandemic and political ideas from Hobbes to Fukuyama.

What I’ve been following in Australia . . .

What happened:

According to the Australian Bureau of Statistics (ABS), the Consumer Price Index (CPI) fell 1.9 per cent in June quarter. In annual terms, the CPI fell 0.3 per cent. 

The trimmed mean – the RBA’s preferred measure of underlying inflation – fell by 0.1 per cent over the quarter and rose by 1.2 per cent over the year and other measures of underlying inflation were similarly weak, with the annual rate of increase for the weighted median sliding to 1.3 per cent. 

Several factors contributed to the June quarter’s abrupt dip into deflation, including some important methodological changes.  Key drivers of the quarterly fall in prices included:

  • An 11.2 per cent fall in the furnishings, household equipment and services group. This was mainly driven by a 95 per cent fall in the CPI for childcare services after the government announced on 2 April that they would be free for families from 6 April to 28 June (later extended until 12 July).This had the effect of reducing childcare out-of-pocket expenses for households to zero for most of the June quarter (for a total of 62 out of 65 business days). This factor alone subtracted about 1.1 percentage points from the headline CPI.
  • A 6.8 per cent fall in the transport group. This drop largely reflected a19.3 per cent fall in automotive fuel, due to low global demand resulting from COVID-19 restrictions (automotive fuel prices fell 15.9 per cent in April and then only rose 0.9 per cent in May and 9.2 per cent in June).Lower fuel prices subtracted almost 0.7 percentage points from the CPI.
  • A fall of 3.7 per cent in the education group. Here the main contributor was a drop of 16.2 per cent in preschool and primary education reflecting the provision of free before- and after-school care and free preschool during term two in NSW, Victoria and Queensland.
  • A one per cent fall in the recreation and culture group. This was driven by two per cent falls for domestic holiday travel and accommodation and for international holiday travel and accommodation. Note that both of these categories were imputed off the all groups CPI (that is, prices for these – and some other series including urban travel and sports participation – were treated by the ABS as having a quarterly change equal to that of the headline CPI, rather than being measured).
  • The Bureau also provided a helpful table showing how these various developments influenced the headline rate:

     CPI exclusion-based measure, June 2020 quarter
      Quarterly change (per cent)  Annual change (per cent)
     Headline CPI  -1.9
     CPI ex. Childcare  -0.8  +0.7
     CPI ex. Automotive fuel  -1.3  +0.5
     CPI ex. Childcare & automotive fuel  -0.1  +1.6
    CPI ex. Childcare, automotive fuel & preschool & primary education  +0.1  +1.8

    Source: ABS

    Other notable declines in the June quarter included a 0.7 per cent fall for the housing group (reflecting sharply lower rents) and a 1.3 per cent drop for the communications group.

    Why it matters:

    The actual outcome in June was pretty close to consensus: the median market forecast had called for a two per cent fall over the quarter and a 0.5 per cent annual decline. But the fact that it wasn’t a surprise shouldn’t take much away from what was still an historic result, with the ABS pointing out that this was the largest quarterly fall in the 72-year history of the CPI. Moreover, until now there had also only been four previous quarters since 1949 in which the annual inflation rate had been negative and none this century: once in the June quarter of 1962 and then for the three quarters between Q3:1997 and Q1:1998.

    Does the drop into negative territory in the June quarter herald the onset of a new era of deflation? Not in the short run. Several factors that contributed the most to falling prices in the June quarter have been reversed in the September quarter, including the ending of free childcare and a recovery in fuel prices. That should be enough to lift the quarterly change in CPI back into positive territory next quarter.  

    In addition, while it’s true that underlying inflation this quarter was weaker than expected (consensus expectations were for a 0.1 per cent quarterly gain and a 1.4 per cent annual rate for the trimmed mean, for example) the weakness in underlying measures of inflation was partly driven by the ABS decision to include imputed series such as domestic and international travel in its calculations. Excluding those imputed series would have pushed the annual rate of increase for the trimmed  mean measure up from 1.2 per cent to 1.5 per cent and the rate of increase for the weighted median up from 1.3 per cent to 1.5 per cent.

    So, next quarter should see the economy back out of its brief deflationary dip.  What about the quarters beyond that? For now, overall inflationary pressures look likely to remain very soft, given the large amount of labour market slack (see next story), subdued economic growth and fragile household confidence.  That story of ongoing disinflationary forces is also consistent with what most of our measures of inflationary expectations are telling us. Survey-based measures, for example, see inflation at or below the bottom of the RBA’s target band.

    And financial market-based measures are also predicting very low rates of inflation.

    In the longer term, of course, the outlook becomes much more uncertain as the potential for an inflation regime shift (perhaps sparked by globally higher public sector debt and deficits or by increasingly radical monetary policy choices) becomes more of a consideration to set against sub-par growth and excess capacity. 

    Finally, this week’s readings also include a couple of interesting pieces on inflation in the time of COVID-19.

    What happened:

    The ABS released the latest data on weekly payrolls, showing that between the week ending 14 March 2020 (the week Australia recorded its 100th confirmed COVID-19 case) and the week ending 11 July 2020, payroll jobs fell by 5.6 per cent while total wages paid declined by 4.8 per cent. Over the most recent week of data, jobs fell by 0.6 per cent and wages fell by 1.9 per cent.

    By state, the largest declines over the 14 March to 11 July period for payrolls jobs were in Victoria (down 7.3 per cent), Tasmania (down 6.8 per cent) and the ACT (down 6.4 per cent), while the largest falls in wages were suffered by Western Australia (down seven per cent), Tasmania (down 6.9 per cent) and Victoria (down 4.8 per cent).