With the December quarter inflation data out of the way, the only thing standing in the way of an interest rate cut at next week’s RBA Board meeting is its own pig-headedness and its crazed obsession with Sydney house prices.
The December quarter CPI confirmed a further marked fall in inflation – the headline rate fell to just 1.7 per cent, the lowest annual reading since March 2012, and the quarterly momentum pointing to yet lower inflation in the next quarter or two. It was below the market forecast. it is only the fifth time since 2000 (that’s 56 quarters) that inflation has been below 2 per cent. The underlying measures were also soft, with the annual increase at just 2.2 per cent, well down on the 2.8 per cent recorded in the June quarter 2014 and spot on the market forecast. The annual underlying inflation rate is now just 0.4 percentage points from being at a new record low. In the last decade, the annual underlying inflation rate has been lower than the December quarter 2014 reading of 2.2 per cent on just two occasions.
Whichever way the CPI data are cut and diced, inflation is low.
There are no hints at all of upside inflation risks and given the mix of global conditions, the plummeting terms of trade, record low wages growth, high unemployment and soppy demand pressures, it is overwhelmingly likely that inflation will remain low or even fall further in the year ahead.
When inflation is too low, monetary policy is too tight. The Year 12 economics to students I talk to get this linkage. For around 18 months, the RBA has held the cash rate steady at 2.5 per cent. These are amongst the highest interest rates in the industrialised world. This is why the Australian dollar remains too high, it is why real GDP growth is mired below trend and it is why the domestic economy remains soft. The Assuie dollar is above 80 US cents as I write this, despite commodity prices being in the doldrums.
As I have been arguing since September last year, the RBA needs to ease monetary policy and it can take that step next week at its regular Board meeting. If it fails to deliver a much needed rate cut, the risk of further disinflation will rapidly build meaning genuine problems for the economy as we go through 2015 and into 2016.
Inflation is dead and buried. The whole world knows it and is setting monetary policy to avoid the risk of deflation taking hold. Let’s see next week if the RBA is aware of what is happening outside the Sydney housing market and acknowledges easier monetary policy is needed to guard against the perniciousness of deflation.