Statement on Monetary Policy – February 2008
Price and Wage Developments
Recent developments in inflation
The CPI data for the December quarter confirmed that inflation pressures have increased over the past year. CPI inflation increased to 3.0 per cent over the year to the December quarter. Based on a range of measures, underlying inflation appears to have increased to around 1 per cent in the December quarter, and 3½ per cent over the past year (Table 13, Graph 65).
The 0.9 per cent outcome for headline inflation in the December quarter reflected broad strength across a range of items. Overall, around 70 per cent of items in the CPI (by expenditure weight) grew at an annualised rate of more than 2.5 per cent in the December quarter (Graph 66). There were particularly large increases in petrol prices, housing costs, and financial & insurance service costs, which were only partly offset by a sharp fall in fruit & vegetable prices.
Non-tradables inflation increased to 1.3 per cent in the quarter, and to 4.4 per cent for the year (after adjusting for the change to the child care rebate in the September quarter), which is equal to the fastest annual rate since 1992 (Graph 67). This reflected strong increases in prices of a wide range of items, including housing, financial & insurance services, and various food items, such as milk and bread. Higher housing costs were the largest contributor to the increase in non-tradables prices both in the quarter and for the year as a whole, with house purchase costs, utilities and in particular rents growing strongly. Rents, which have a weight of around 5½ per cent in the CPI, rose by 1.6 per cent in the December quarter, to be 6.4 per cent higher over the year. This was the largest annual increase since early 1990. With rental vacancy rates around historical lows, it is likely that there will be continued strong growth in rents for some time (Graph 68).
Retail petrol prices increased by 7 per cent in the December quarter and by 14 per cent over the year, largely driven by the recent sustained strength in world oil prices (Graph 69). Excluding the volatile fuel and food components, tradables prices were unchanged in the quarter and 0.8 per cent higher over the year (Graph 67). Tradables inflation is likely to have been restrained somewhat by the trend appreciation of the exchange rate over the past few years and by declines in the prices of many manufactured goods. For example, motor vehicle prices have fallen by 0.5 per cent over the past year, while prices of audio, visual & computing equipment fell by 4 per cent in the quarter, to be 11 per cent lower over the past year.
Producer prices increased solidly in the December quarter. Final-stage prices increased by 0.6 per cent in the December quarter, to be 2.8 per cent higher over the year, with strong increases in domestic producer prices but falls in prices of imported items (Graph 70). Abstracting from movements in oil and fresh food prices, domestic producer prices rose by 4.0 per cent over the year, driven by price increases in the construction and property services sectors, and some manufactured food products. Producer prices for imports fell by around 6 per cent over the year, largely reflecting the appreciation of the exchange rate.
Overall, the data on domestic inflation indicate a pick-up in pressures over the past year, with underlying inflation in 2007 running noticeably higher than expected by the Bank and other forecasters a year ago. A number of factors appear to have contributed, with the appreciation of the exchange rate over 2007 being the only significant offsetting factor. Most notably, the growth in the domestic economy has been stronger than expected. Whereas non-farm growth had been expected to be around 3¼ per cent over 2007, the available data indicate growth of 4½ per cent over the year to the September quarter 2007; this is presumably partly related to the fact that growth in Australia’s major trading partners in 2007 was stronger than expected. Associated with the strength in output, the labour market tightened further through 2007, with strong employment growth and a fall in the unemployment rate. Finally, materials cost pressures have been significant, with oil prices rising from around US$60 per barrel in early 2007 to more than US$90 per barrel at year-end and high prices for a range of other commodities, especially food.
As discussed below, the strength of the domestic economy and the heightened pressures on capacity have resulted in strong growth in labour costs and a pick-up in surveyed inflation expectations, which are both likely to have contributed to the pick-up in underlying inflation. In addition, it is likely that the strength of demand has allowed some growth in business margins. Although they are difficult to measure, estimates based on ABS profits data suggest that margins in the goods distribution sector (retail and wholesale trade, plus transport) and the broader economy have recently been at fairly high levels (Graph 71). Data from the NAB survey on the net balance of respondents increasing margins also suggest some increase in margins in 2007 in both the retail sector and the broader economy, after a period when they had been declining.
Recent data indicate strong growth in labour costs, in line with conditions in the labour market and reported shortages of suitable labour. The wage price index (WPI) grew by 1.0 per cent in the September quarter, to be 4.2 per cent higher over the year, which is around the level of recent years, but above the average for the period for which this series is available (Graph 72). The average annualised wage increase for federal enterprise bargaining agreements (EBAs) certified in the September quarter eased a little to 3.8 per cent (adjusted for changes in industry composition). While EBA outcomes have been volatile over the past two years or so, they have been broadly tracking growth in the WPI measure. Both EBAs and the WPI have narrower coverage than the measure of average earnings in the national accounts which includes wage and non-wage labour costs. This increased by 5.9 per cent over the year to the September quarter, the strongest increase since 1996. While the national accounts measure can be quite volatile, the underlying trend seems to have picked up in recent quarters. Overall these data suggest that there has been somewhat more pressure on wages and benefits than indicated by the growth of the wage price index, and that growth in labour costs has been running at a higher level than is consistent with inflation remaining near the centre of the target range.
While economy-wide WPI wages growth has been relatively contained over recent years, state-level outcomes have been quite diverse. Over the past two years, wages growth was strongest in the resource-rich states of Queensland and Western Australia, where labour markets were also tightest; they have the lowest unemployment rates and business surveys and the Bank’s liaison program indicate that skilled labour shortages are particularly prevalent in these states (Graph 73). The relatively high wages growth has been fairly broad-based across industries in these states. In contrast, wages growth has been lower across most industries in New South Wales and Victoria, moderating national WPI growth.
Inflation expectations in the economy seem to have picked up in recent quarters to be relatively high. The Melbourne Institute survey of households reports that the median expectation for consumer price inflation over the year ahead has averaged 4.3 per cent over the three months to January, up from 3.8 per cent over the previous three months, and well above the average of 3.0 per cent over the inflation-targeting period (Graph 74). Medium-term inflation expectations implied by indexed bond yields are also around their highest levels in a number of years, although this may partly be because real yields are being compressed by the tight supply of indexed bonds in Australia. In addition, business surveys indicate that the proportion of businesses expecting to increase prices in the near term remains above long-run average levels.
Market economists surveyed by the Bank following the release of the December quarter CPI have increased their inflation forecasts. The median expectation for headline inflation over the year to the December quarter 2008 rose to 3.0 per cent, with the expectation for the following year at 2.7 per cent (Table 14). These one- and two-year ahead forecasts are around the highest levels seen in the past decade. Union officials have also increased their inflation expectations.