Statement on Monetary Policy – February 2009 Price and Wage Developments

Recent developments in inflation

Consumer price data for the December quarter suggest the pace of inflation has moderated, following a period when it had been quite high. The CPI fell by 0.3 per cent in the quarter, to be 3.7 per cent higher over the year (Table 12, Graph 81). Looking across a range of measures, underlying inflation was around ¾ per cent in the quarter – compared with over 1 per cent in earlier quarters – and around 4¼ per cent over the year. In year-ended terms, both headline and underlying inflation appear to have peaked in the September quarter 2008.

Although price pressures remained quite broad-based – around 60 per cent of items in the CPI had annualised price increases of 2.5 per cent or more in the quarter – developments in a few items with large weights held down the CPI. The main contributor to the fall in the CPI in the quarter was an 18 per cent decline in petrol prices, which subtracted 0.9 percentage points from inflation. In addition, there was also a decline in the estimated cost of deposit & loan facilities following recent reductions in the cash rate, a significant fall in motor vehicles prices, and a slowing in housing cost inflation. In contrast, prices of almost all food items rose and inflation remained strong for a range of services. The overall slowing in non-tradables inflation in the CPI data provided some evidence of the easing in price pressures that the Bank has been expecting due to the slowing economy (Graph 82). The pace of tradables inflation (excluding food and fuel) was broadly unchanged, but is likely to increase in 2009 due to the large depreciation of the Australian dollar during the second half of 2008.

Costs and margins

Official data suggest that growth in labour costs in the September quarter remained relatively firm, although information from business surveys and liaison points to some moderation in the period ahead, in line with the softening in labour market conditions.

The wage price index (WPI) grew by 0.9 per cent in the September quarter, leaving year-ended growth running at around the 4 per cent pace seen during the past few years, but above the average rate of the 11-year history of the series (Graph 83). Annual growth in public sector wages was slower than that in the private sector, partially due to ongoing delays in renegotiating expired public sector collective agreements. In particular, this contributed to a softer outcome for New South Wales, which recorded total WPI growth of only 3.7 per cent in year-ended terms, the lowest of the states. Western Australia again recorded the strongest annual growth of 5.1 per cent, despite some moderation over the past year.

Most other measures of wages also continued to grow at a pace above the average for the inflation-targeting period. The national accounts measure of average earnings grew by 1.5 per cent in the September quarter and by 4.7 per cent over the year, and the measure of ordinary time earnings from the average weekly earnings survey presented a similar picture. The average annualised wage increase provided by federal enterprise bargaining agreements formalised in the September quarter was 4.1 per cent. However, consistent with the slowing in economic activity, measures of current and expected labour costs from business surveys show an easing in wage pressures (Graph 84); information from business liaison suggests this trend will continue into 2009.

Producer price inflation remained firm in the December quarter, abstracting from the sharp fall in oil prices. Domestically generated upstream price pressures moderated in the quarter, but there was a sharp rise in import prices (Graph 85). The easing in domestic prices was most apparent at the final stage of production, where a significant fall in construction costs in Victoria held down overall price growth. Final stage domestic producer price inflation (excluding oil) slowed to 0.5 per cent in the quarter, after averaging around 1½ per cent in the previous three quarters. In contrast, import prices rose by 17 per cent in the quarter, reflecting the sharp depreciation of the exchange rate.

Recent data on business margins, based on ABS profits data, suggest that margins – including in the goods distribution sector that comprises retail & wholesale trade and transport – declined slightly in the September quarter, but remained at above-average levels (Graph 86). Nonetheless, recent information from the Bank's liaison points to considerable pressure on margins across a range of industries. Importers suggest that the depreciation of the Australian dollar has put upward pressure on prices, although distributors and retailers report that it will be difficult to pass on the higher cost of imports in full due to soft consumer demand and ongoing competitive pressures.

Inflation expectations

Inflation expectations have declined significantly over recent months according to a range of measures. Consumer inflation expectations, as measured by the Melbourne Institute survey, fell to 2.7 per cent in January, compared with almost 6 per cent in mid 2008, although this indicator is quite volatile (Graph 87). Likewise, measures of inflation expectations derived from financial markets have fallen.

Market economists surveyed by the Bank following the release of the December quarter CPI expect inflation to moderate further in the near term. The median expectation for headline inflation over the year to the June quarter 2009 is now 2.0 per cent, compared with 3.4 per cent in November (Table 13). Over the year to the June quarter 2010, the median inflation expectation is 2.5 per cent. Surveys of both businesses and union officials also generally suggest that inflation expectations have eased in recent months.