Renewed speculation of an interest rate rise this year has come out of a surprise surge in Australia’s underlying inflation figures.
But don’t blame it on the price of bananas, says Grattan Institute economist Saul Eslake.
Firstly, what’s driving the consumer price index (CPI) increases in items such as food and fuel?
In the case of food it is movements in the prices of underlying commodities. Some of those, most obviously bananas, is the result of cyclones earlier this year and the increase in banana prices has been roughly commensurate with what happened after Cyclone Larry when they rose by 500%.
Of course, people haven’t spent that much more on bananas because there haven’t been that many bananas to buy. The consumer price index (CPI) is a fixed weight index, that is, the weight which each item in the CPI carries is based on consumer spending patterns in a base period. This doesn’t change from quarter to quarter, even if consumer spending patterns actually do fall, as they have done in this case.
So that means to some extent the prices that consumers have actually been paying hasn’t risen by as much as what the CPI figures suggest.
Of course, banana prices wouldn’t have risen as much as they have done if the government was prepared to allow the imports of bananas, which they haven’t done – in my view, unwisely.
The Reserve Bank has said it is aware of these distortions and will “look through” them, as it will the subsequent falls in banana prices that will occur in the second half of this year as new production comes back on the market.
Hence these movements in banana prices, which added 0.2% to the CPI in the June quarter, will have no impact on interest rates.
Just what is with this obsession with bananas?
Twice in six years, cyclones have wiped out a large proportion of the banana crops and triggered huge increases in prices.
As I say, these price increases would not have occurred if the government had been prepared to allow the import of bananas.
But because of alleged concerns of biosecurity, the banana growers union has prevented any imports of bananas based on what I think is the spurious assertion that even to allow the import of appropriately sprayed fruits through southern ports like Melbourne would carry the risk of introducing exotic diseases that would threaten banana plants thousands of miles to the north.
To me that sounds like the same kind of argument that European, American and Japanese agricultural interests have used to block Australian imports, which makes us pretty cross.
Given this supply volatility then, should bananas be given the weighting they are in the CPI index?
Well, that’s just the way indexes work. Because the ABS can’t survey every quarter exactly how much of each item people buy, the CPI is compiled on the basis of movements in the prices of things which the ABS surveys every quarter. (In some cases, like petrol, they do this every week.)
They just roll this through the CPI in a mechanical way. It’s then up to people who analyse the CPI to take those things into account where they know they are relevant, which is what the Reserve Bank does.
Crude oil prices have been fairly high and even though the rise in the Australian dollar will have mitigated the impact of higher crude oil prices to some extent, it clearly hasn’t been enough to prevent Australians paying higher petrol prices.
While people can avoid buying bananas because they don’t like the price, they obviously have far less choice when it comes to buying petrol.
As it happened, vegetable prices fell, presumably because they were boosted as a result of the floods in Queensland and northern NSW in January. Some vegetables have much shorter growing cycles than bananas so it was much easier to get normal supplies back and hence prices fell from their high levels in the March quarter. Another example is meat prices, which have been high globally in part because of high demand for meat.
The underlying measures which the Reserve Bank looks at which seek to abstract from these more volatile and extreme items – the so-called weighted median and trimmed mean measures – rose by 0.9% in the June quarter, which is equivalent to an annualised rate of 3.5%. The Reserve Bank wants to see inflation at between 2% and 3%, so they won’t be very happy about that.
It may be that there is one other odd component of the CPI that has tricked them before, which appears to be playing up in the two quarters and that is the ABS measure of the price of deposit and loan products.
That is measured in part through the fees that banks charge, but also measured by the spread between rates on loans and rates on deposits. You’ll remember famously during and for a while after the financial crisis, that spread widened because banks didn’t pass on all the reductions of official rates, or raised them by more than what rates went up.
The last time that occurred in a headline sense was in November-December last year, but of that impact appears to flowed through, particularly in the March quarter, but also to some extent in the June quarter as well.
This is a component of the CPI which the Reserve Bank has a lot of problems with. They have doubts whether the ABS is accurately capturing what is going on here and it has produced some perverse implications on the CPI before, particularly around 2006 when these components actually dragged the CPI down and arguably caused the Reserve Bank to delay raising rates when objectively it probably should have put them up.
So the Reserve Bank views that component of the CPI with a fair bit of suspicion. If you take that component out as well then the underlying measures aren’t quite as bad the 0.9% looks on the surface.
Bearing in mind that the Reserve Bank also noted some downside for the world economy and seems to have given a bit more weight to some of the weakness to other non-mining areas od the domestic economy, I don’t believe they will be raising rates next week.
However, any way you look at it, underlying inflation was higher than expected which ought to put paid to any suggestion that the next rates movement, whenever it happens, will be down. The next movement - when it happens, and I don’t think it will be next week – will be up.
That is, unless there is major downturn in the global economy, for example as a result of the US defaulting on its debt. And that’s certainly a risk, although the financial markets appeared to have downplayed this.