Statement on Monetary Policy – August 2009 Price and Wage Developments
Recent developments in inflation
Inflationary pressures in the domestic economy continue to moderate. Upstream price pressures have eased considerably over the first half of 2009 and there are signs of moderation in wage growth. In addition, inflation expectations remain well contained. Year-ended consumer price index (CPI) inflation has recorded its lowest outcome in a decade. Measures of underlying inflation remain quite high, but are declining gradually, in line with the Bank's expectations.
The CPI increased by 0.5 per cent in the June quarter, to be 1.5 per cent higher over the year (Table 12, Graph 77). The main contributors to the quarterly rise were price increases for automotive fuel, hospital & medical services and rents, partly offset by falls in the prices of deposit & loan facilities, fruit and vegetables. Excluding volatile items and deposit & loan facilities, prices rose by 0.8 per cent in the quarter to be 3.6 per cent higher over the year. Based on a range of measures, the Bank's assessment is that underlying inflation was around 0.8 per cent in the quarter and 3¾ per cent over the year, compared with a rate of just over 4½ per cent in September 2008.
The current divergence between measures of underlying inflation and headline CPI inflation is larger than it has been for almost 25 years. The divergence is largely attributable to two factors. The first is a 21 per cent decline in fuel prices over the past year, which has subtracted 1 percentage point from CPI inflation (Graph 78). This decline has been driven by movements in global oil prices, which fell sharply from elevated levels in mid 2008, before recovering somewhat in the June quarter. The second factor is an 18 per cent fall in the price of deposit & loan facilities over the past year, which has subtracted nearly a further percentage point from CPI inflation. This fall is the result of a narrowing in the ABS estimate of the difference between interest rates on deposit and loan products used by households.
The moderation in underlying inflation over recent quarters reflects an easing in non-tradables prices (Graph 79). Excluding deposit & loan facilities, year-ended non-tradables inflation has moderated by a percentage point since the September quarter 2008, to be 4.2 per cent in the June quarter. This is mostly accounted for by an easing in inflation for housing and a number of food items. Housing cost inflation has slowed from almost 7 per cent to just over 5 per cent in recent quarters, with an easing in inflation for both new housing and rents. Similarly, inflation in food items classified as non-tradable has slowed from nearly 7 per cent to 4 per cent in recent quarters, reflecting a broad-based easing. In contrast, tradables prices (excluding food and fuel) rose solidly for a second consecutive quarter, increasing by 1.0 per cent to be 1.9 per cent higher over the year. This pick-up in tradables inflation has been broad-based and continues to reflect the effect of the currency depreciation in the second half of 2008, although this impact is likely to moderate over the coming year as the more recent appreciation begins to flow through.
Costs and margins
Official measures suggest that there was some moderation in the growth in labour costs in the March quarter, driven by an easing in private-sector wage growth. More timely indicators suggest that this has continued over recent months, consistent with the weakening of the labour market.
The wage price index (WPI) increased by 0.8 per cent in the March quarter, a below-average outcome for this series, after growing at a firm pace throughout 2008 (Graph 80). In year-ended terms, WPI growth moderated slightly to 4.2 per cent, reflecting a decline in growth in the private-sector component. Growth in the measure that includes bonuses has moderated more noticeably over the past year, after picking up in 2007.
Other measures of wage growth also moderated in the March quarter. Ordinary-time earnings as measured by the average weekly earnings survey grew by 1.2 per cent in the quarter, following strong growth of around 1¾ per cent in the previous two quarters. Growth in the national accounts measure of average earnings – in principle the broadest measure of earnings, but quite volatile – was very weak in the quarter, possibly reflecting declining bonus payments. In contrast, the average annualised wage increase in new federal enterprise bargaining agreements certified in the quarter picked up somewhat, from 4.3 per cent to 4.6 per cent. However, the coverage of agreements certified in the quarter was relatively small and recent agreements in the construction industry had a larger than usual influence.
More timely indicators of labour cost growth point to further moderation in coming quarters. The Bank's business liaison suggests that the proportion of firms expecting to increase wages over the year has fallen from over 90 per cent to around two-thirds. Business surveys taken in the March and June quarters also suggest that labour cost growth is likely to continue to moderate over the period ahead.
The recent decision by the Australian Fair Pay Commission (AFPC) to leave the federal minimum wage and basic award rates unchanged in 2009 will also contribute to wage moderation over the coming year (Graph 81). The principal reason given for the decision, which followed a 4 per cent increase in 2008, was the risk of higher unemployment from increasing wages in a time of labour market weakness. The AFPC argued that the social impact on low-paid employees of job losses or reduced working hours is more significant than the impact of leaving the minimum wage unchanged. It also argued that the safety net has been maintained by changes to the tax/transfer system and government stimulus packages. The AFPC's decision is estimated to directly affect around 15 per cent of the workforce, with various estimates suggesting that at least as many employees may also be indirectly affected.
Upstream price pressures continued to abate in the June quarter, with the easing relatively broad-based (Graph 82). Excluding oil, preliminary stage producer prices fell by 2.8 per cent and final stage prices fell by 0.9 per cent in the quarter. Earlier declines in global commodity prices contributed – coal, steel and chemicals prices all fell – along with a 6 per cent decline in final stage import prices as the currency appreciated (although import prices remained 16 per cent higher over the year). All industries recorded lower prices in the quarter, with the weakest outcomes in property & business services and manufacturing, both of which recorded price falls of over 1 per cent. Construction prices fell slightly in the quarter, reflecting persistent weakness in non-residential prices which were down by 3½ per cent over the year.
Recent estimates of business margins, based on ABS profits data, suggest that margins in the broader economy declined slightly in the March quarter, to be somewhat below the average level of recent years. The NAB survey also suggests that margins have declined in recent quarters, although fewer firms are now expecting margins to continue to contract.
Inflation expectations
Inflation expectations remain well below the elevated levels of mid 2008, although they have risen a little in recent months. Consumer inflation expectations, as measured by the Melbourne Institute survey, drifted up to 3.2 per cent in July, which is around the average level over the past decade (Graph 83). Measures of inflation expectations derived from financial markets have also drifted up a little over recent months, to be a little over 2½ per cent.
Market economists surveyed by the Bank following the release of the June quarter CPI expect headline inflation to remain at relatively low levels in the near term. The median expectation for headline inflation over 2009 is now 1.7 per cent, compared with 2.1 per cent in May (Table 13). Over 2010, the median inflation expectation is unchanged at 2.4 per cent. Surveys of both union officials and businesses also generally suggest that inflation expectations remain well below their average level over recent years (Table 13, Graph 84).