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Why Australia's low inflation is a game changer

Stephen Koukoulas

The September quarter inflation data could well be a game changer in the economic policy debate.

Australia’s inflation rate is low.

Too low it could be argued and the economy may be in need of a bit more stimulus to kick things along.

Not all that often does a number come along to materially change the assessment of the economy, but the inflation result today could be one of those.

The annual headline rate of inflation, at 1.5 per cent, is well below the RBA target.

It has been below 2 per cent for a year and has been 1.5 per cent or less for the last three quarters.

Also read: Inflation rose 0.5% in the September qtr

The underlying inflation rate of inflation is also falling.

These underlying measures strip out large, volatile and usually one off jumps or falls in prices to get a truer reading of inflation.

Things like petrol prices, which are driven by global events and not the performance of the local economy, are often excluded.

So too items where there may have been a tax change – for example cigarettes, electricity prices or alcohol.

Or famously banana prices in 2011 when Cyclone Yasi hit crops and caused a shortage and a price spike.

Underlying inflation rose just 0.2 per cent in the September quarter which is one of the lowest readings ever recorded.

The annual increase of 2.2 per cent is similarly near a record low and if the next quarterly reading is 0.3 per cent or less, underlying inflation will drop below 2 per cent.

Also read: $A higher after US inflation data

This is suggesting that all is not well with the economy, especially when the depreciation of the Australian dollar is unable to be passed through to consumers, or so it seems.

The big question now, and one that the RBA will spend a lot of time contemplating at its Board meeting next Tuesday, is the outlook for inflation.

Or rather it will look at the economy asking the question, ‘is the current 2.0 per cent rate of official interest rates consistent with keeping inflation within the target range over the next year or two?’.

Despite the recent increase in bank mortgage rates, the RBA would realise that the cuts in official interest rates in the first half of 2015 are still working their way through the economy.

That is the sober assessment of things. The RBA will also be delighted with the extremely low level for the Australian dollar and will be confident that this will be a key driver in supporting economic growth into 2016.

There are still many positive aspects about the growth outlook.

But the inflation rate implies that the economy could be given a kick start, one way or another, with the objective of boosting growth and lowering unemployment, all with the inflation outlook remaining consistent with the target.

The most likely outcome for the RBA is that it will leave interest rate unchanged next week but the door is opening wider that the next move in interest rates will be a cut.

Stephen Koukoulas is a Yahoo7 Finance expert with more than 25 years experience as an economist in government, as Global Head of economic and market research, as Chief Economist for two major banks and as economic advisor to the Prime Minister of Australia.