Inflation contained but Swan warns of tough budget decisions ahead

Inflation remains within the Reserve Bank of Australia’s target range.

Australia’s inflation rate remains under control, potentially adding to the argument for the Reserve Bank to leave interest rates where they are, experts said today.

But one economist has warned the Reserve Bank of Australia should be concerned about deflation.

Australia’s consumer price index (CPI) rose 0.4% in the March quarter of this year, according to new Australian Bureau of Statistics data, putting inflation within the central bank’s target range.

Treasurer Wayne Swan said the figure showed inflation was contained but has warned the impact of high Australian dollar could lead to some “difficult and tough decisions in this year’s budget”.

The CPI measures price variations in 87 items that reflect average household spending patterns and is one of the factors the RBA will consider when it makes a decision on interest rates in May.

The ABS said that the 0.4% CPI rise in the March quarter 2013 compared with a rise of 0.2% in the December quarter 2012.

“The most significant price rises in the March quarter 2013 were for new dwelling purchase by owner-occupiers (+1.7%), pharmaceutical products (+7.6%), tertiary education (+6.5%) and tobacco (+3.7%). The most significant offsetting price falls were for international holiday travel and accommodation (–5.2%), furniture (–6.8%) and fruit (–7.0 %),” the ABS said in a press release.

“The CPI rose 2.5% through the year to the March quarter 2013, compared with a rise of 2.2% through the year to the December quarter 2012.”

The Australian dollar fell following release of today’s CPI data.

Tough budget decisions

Federal Treasurer Wayne Swan said today’s figures showed that inflation was under control.

“I think it’s pretty fair to say that contained inflation and the low interest rates that we have is good news for family budgets,” he said.

“But the high dollar is weighing on prices. The flip side of the high dollar weighing on prices is that this is putting immense pressure on the profitability of many businesses large and small right across our economy,” said Mr Swan.

“Of course, just as the high dollar is affecting the profitability of businesses, it’s also having a very big impact on government revenues across the forward estimates, largely through the impact on profits and prices,” he said.

“This sustained hit to revenues means we are going to have to make some difficult and tough decisions in this year’s budget.”

Rates likely to hold

Dr Remy Davison, Jean Monnet Chair in Politics and Economics at Monash University, said today’s CPI data showed a slight increase over 2012, but lower than market expectations, and within the RBA’s target range.

“It leaves the door open for a rate cut, but the national property data, which was buoyant in the March quarter, suggests the RBA will leave interest rates on hold for the time being, until national and global market conditions become clearer by midyear,” Dr Davison said.

“Clearly, the continuing strong exchange-rate performance of the Australian dollar contributes to downward price pressure on discretionary spending such as overseas travel. However, tertiary education costs are rising, attributable partly to a blow-out in Commonwealth-funded places, as more students take up the option of postgraduate study.”

Some of the falls in food prices were attributable to lower prices (or even below-production-cost prices) commanded by domestic farmers, as well as import competition deflating wholesale and retail prices, he said.

Professor Graeme Wells, Associate Professor at the University of Tasmania’s School of Economics and Finance, said the yearly CPI rate was “wobbling around 2.3% or 2.4% or 2.5%, which is about where it ought to be.”

“My guess is this implies the central bank won’t be cutting interest rates. It would have had to have been a lower quarterly rate for them to have any inclination to cut interest rates,” he said.

‘Inflation bogey’

Professor Steve Keen, Associate Professor, School of Economics and Finance at the University of Western Sydney said central banks, in general, had an “obsession with keeping inflation rates low, as if that’s going to benefit economic growth.”

“That has actually set us up for a debt crisis. They ignored ballooning levels of private debt, they are obsessive about getting the rate of inflation down,” he said.

“Now that inflation is either very, very low or going towards deflation, it means it’s incredibly hard to reduce the real burden of private debt. If the RBA keeps its rate set at 3%, which they currently are, then we are talking about a real rate of now getting close to 2%. That’s not the rate you have when the economy is in a slump,” he said.

Professor Keen said problems could arise if there was a big gap between the interest rate and the inflation rate.

“[The RBA] think they are stimulating the economy by having the interest rate at 3% but if the inflation rate is well below 3%, they are either slowing the economy down or, more importantly, keeping the value of the dollar high. That’s one of the main things they are doing wrong. They thought they were putting rates up to fight inflation but in fact the economy is going into deflation,” he said.

“The inflation rate has been less than they expected it was going to be,” Professor Keen said.

“Again, it shows the Reserve Bank has been behind the ball and worried about an inflation bogey when, in fact, it’s deflation they should have been worried about.”