Australia markets open in 1 hour 20 minutes

    +42.80 (+0.59%)

    -0.0063 (-0.90%)
  • ASX 200

    +40.70 (+0.58%)
  • OIL

    -0.73 (-0.82%)
  • GOLD

    -0.60 (-0.03%)

    -84.07 (-0.25%)
  • CMC Crypto 200

    -2.02 (-0.38%)

Inflation stirs from record low: What this means

·4-min read
Image of pedestrian walking through Sydney CBD; image of masked RBA Governor Philip Lowe
Inflation is showing signs of stirring, independent economist Stephen Koukoulas writes. (Source: Getty)

That squeeze on your personal finances over the past year is real. At a time when annual wages growth has been stuck around 2 to 2.5 per cent, inflation was 3.8 per cent.

To be sure, there is a quirk in the annual inflation rate through to the June quarter 2021 with the so-called base effect from the low point of the 2020 lockdowns washing out of the data.

While inflation is clearly not as high as the headline figure suggests, price pressures are starting to stir.

More from The Kouk:

While the overall change in prices, that is 3.8 per cent, is most relevant to most household’s cost of living, from a monetary policy perspective, it is underlying inflation that matters most.

Underlying inflation strips out what are often one-off price changes, such as the move to free childcare in 2020 which was a temporary move with no link to demand and supply pressures in the economy more generally.

The fact that scheme ended in July 2020 is one reason why the annual inflation rate is so high.

So too with the home building grants from the government which have lowered to price of new housing. These have come to an end too.

Stripping out the one-offs like these and the annual increase in underlying inflation was just 1.6 per cent which was, incidentally, the highest since March 2020.

Recall the RBA has a target for annual inflation of between 2 and 3 per cent and for that if effectively uses the underlying measure.

CANBERRA, AUSTRALIA - FEBRUARY 03: Reserve Bank of Australia Governor Philip Lowe delivers his address at the National Press Club on February 03, 2021 in Canberra, Australia. In the first meeting of the year held earlier this week, the Reserve Bank of Australia board decided to hold the cash rate target at 0.1 percent but Mr Lowe repeated the rate would not move up until actual inflation rises between 2 and 3 percent which is not expected to happen until 2024 at the earliest. (Photo by Sam Mooy/Getty Images)
Reserve Bank of Australia Governor Philip Lowe. (Photo by Sam Mooy/Getty Images)

For the best part of a decade, underlying inflation has been below 2 per cent. This was driven by a number of factors including an extended period of weak economic growth after the global financial crisis and excessively tight monetary policy from the RBA which, pre-pandemic, was implicitly targeting house prices and higher unemployment rather than inflation.

It has used the cover of the pandemic to recast policy with one eye on full employment and the other on having inflation consistently within the target range.

WATCH BELOW: US Federal Reserve optimistic about economy despite Delta, inflation worries

So how is the RBA doing now?

A closer look at the quarter-by-quarter changes in underlying inflation are hinting at some inflation lift. It’s not a lot, but there just might be some good news with inflation starting to lift.

Using inflation in six-monthly blocks, rather than quarterly and the following trend shows.

In the first half of 2020, the annualised underlying inflation rate was 0.9 per cent. In the second half of 2020, this edged up to an annualised pace of 1.5 per cent.

In the most recent half year, to June 2021, underlying inflation has edged up to an annualised rate of 1.8 per cent which was equal to the highest half yearly rise in over 5 years.

It looks like inflation was getting back on track.

Or should that be it 'looked' like it was?

The current lockdowns are changing things

Until these latest COVID-19 lockdowns, especially in NSW, the strength in the economy and the spectacular drop in the unemployment rate was building a broad expectation that inflation pressures were starting to stir.

To be sure, and as noted above, this was from a low base, but the good economic forecasters were looking for inflation to lift to the middle of the RBA target range during 2022.

This trajectory is now unclear. It depends, in part, on any more lasting damage to the economy from the current lockdowns and how potent the recovery is when things finally open up, presumably when most people have been fully vaccinated.

An optimistic take would say that the current recession will be relatively short lived and the positive economic momentum has been deferred by up to 6 months.

It would also mean that the expected lift in inflation has also been pushed back 6 months and that it will be latter 2022, rather than early 2022 before it returns to the mid-point of the RBA range.

A less rosy view would have this current lockdowns materially changing the business and consumer optimism and that spending, investing and hiring decisions have been jolted to a lower growth path over the more medium term.

As a result, any further acceleration in inflation would be dampened.

Suffice to say the COVID-19 pandemic and the reaction to it remains a vital aspect of the economic outlook.

The bottom line is that inflation is still low but is starting, ever so gently to pick up. This is good news, if it can continue, because it will mean the economy is back on track.

Follow Yahoo Finance on Facebook, LinkedIn, Instagram and Twitter, and subscribe to the free Fully Briefed daily newsletter.

Our goal is to create a safe and engaging place for users to connect over interests and passions. In order to improve our community experience, we are temporarily suspending article commenting