Inflation

<p>Australia&#39;s inflation, a key metric in the RBA&#39;s future interest rate calls, rose 0.6 per cent over the March quarter, according to data released by the ABS.</p>

<p>The consumer price index (CPI)&nbsp;came in materially lower than what was forecasted across markets and broadly in line with the RBA&#39;s below market expectation.</p>

<p>Westpac was forecasting a one per cent lift in the CPI, with AMP Capital forecasting a 0.9 per cent rise.</p>

<p>The RBA&nbsp;say they will not increase the cash rate until actual inflation is sustainably within the two to three per cent range.</p>

<p>[smartcode_project:default project_id=27728]</p>

<p>For this to occur, wages growth will have to be materially higher than it is currently, which&nbsp;will require significant gains in employment and a return to a tight labour market, the RBA noted at its April board meeting.</p>

<p>The latest results will unlikely change the RBA&#39;s thinking that rates won&#39;t move until 2024 at the earliest.</p>

<p>CPI was 1.1 per cent up annually, compared to the forecasted 1.4 per cent.</p>

<p>New dwelling prices declined 0.1 per cent over the quarter, namely due to the impact of the Federal Government&#39;s HomeBuilder grant and similar grants by Western Australian and Tasmania state governments.</p>

<p>&quot;Without the offset from these grants, the price of new dwelling would have risen, reflecting increases in materials and labour prices in response to strong demand&quot;, head of prices statistics at the&nbsp;ABS&nbsp;Michelle&nbsp;Marquardt said.</p>

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The consumer price index (CPI) came in materially lower than what was forecasted across markets



Joel Robinson

RBA unlikely to advance interest rate moves after lower than expected inflation figures

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<p>GUEST OBSERVER</p>
<p>The Consumer Price Index – the main measure of inflation in Australia – rose by 0.4 percent in the June quarter, in line with expectations.</p>
<p>In seasonally adjusted terms the CPI rose by 0.6 percent. The annual rate of inflation fell from 1.3 percent to 1.0 percent – equalling the low set in June 1999. So inflation stands at a 17-year low. </p>
<p>The Reserve Bank monitors three measures to derive the underlying inflation rate. The trimmed mean rose by 0.5 percent in the June quarter (1.7 percent annual); the weighted median rose by 0.4 percent (1.3 percent annual) and the CPI less volatile items rose by 0.3 percent (1.6 percent annual). Overall, underlying inflation rose by 0.4 percent in the quarter and by 1.53 percent over the year – a record low.</p>
<p>Petrol prices rose by 5.9 percent in the quarter with medical and hospital services up by 4.2 percent, tobacco up by 2.1 percent and new dwelling purchase up 0.9 percent. The CPI was dragged lower by a 3.7 percent fall in domestic holiday costs, a 1.3 percent fall in car prices and 1.5 percent fall in telecom equipment and services.</p>
<p>Education fees rose 3.3 percent over the year – the slowest growth on record. A raft of goods fell at a record annual rate including breakfast cereals, wine, snacks &amp; confectionary and communication. </p>
<p><a href="/images/2016/07/28/Screen%20Shot%202016-07-28%20at%208.21.34%20AM.png" target="_blank">Click to enlarge</a></p>
<p><img src="/images/2016/07/28/Screen%20Shot%202016-07-28%20at%208.21.34%20AM.png" alt=""></p>
<p>What does it all mean?</p>
<p> Price pressures are contained. Clearly this is not a new development and certainly not one confined to Australia. Consumers can buy goods anywhere and anytime with internet purchases transforming businesses across the globe. Competition is keeping downward pressure on prices and margins and causing businesses to look first at cutting costs before opting to lift prices. And disruption is adding to the competitive forces – developments like Airbnb and Uber are challenging mainstream industries and businesses.</p>
<p>Inflation is stubbornly below the Reserve Bank’s 2-3 percent target band. And importantly it is unlikely the Bank will look to revise the target any time soon. The only way that the Reserve Bank can seek to lift the inflation rate to the target band is by running the economy at a faster rate and that means cutting interest rates. So a rate cut will be on the agenda at the Reserve Bank Board meeting next Tuesday.</p>
<p>Will a rate cut actually boost growth? It is far from certain, but the Reserve Bank has to try. But the Reserve Bank won’t continue to cut rates if it’s clear that interest rates at super-low levels have become ineffective in boosting demand.</p>
<p>Before today’s data the Reserve Bank had assumed an annual headline CPI result near 1 percent in the June quarter with the underlying rate at 1.5 percent. Those forecasts have been realised. But the Reserve Bank had tipped inflation to stay locked between 1.5-2.5 percent over the next two years. So even before the latest data the Reserve Bank held open the possibility of a rate cut with inflation expected to remain at or below the bottom end of its 2-3 percent target range.</p>
<p> Low inflation isn’t confined to certain parts of the economy – it is very much an economy-wide phenomenon. In fact the core measure of market-determined services (excludes volatile items) actually fell by 0.2 percent in the quarter. It’s not just goods but also services that are getting cheaper. Consumers are kings and queens in the current environment.</p>
<p><a href="/images/2016/07/28/Screen%20Shot%202016-07-28%20at%208.22.36%20AM.png" target="_blank">Click to enlarge</a></p>
<p><img src="/images/2016/07/28/Screen%20Shot%202016-07-28%20at%208.22.36%20AM.png" alt=""> </p>
<p>What do the figures show?</p>
<p>Consumer Price Index</p>
<p>The All Groups Consumer Price Index (CPI) rose by 0.4 percent in the June quarter, broadly in line with expectations. In seasonally adjusted terms the CPI rose by 0.6 percent. The annual rate of inflation fell from 1.3 percent to 1.0 percent – equalling the low set in June 1999. So inflation stands at a 17-year low.</p>
<p>Underlying measures of inflation were generally in line with forecasts in the June quarter. The trimmed mean rose by 0.5 percent in the June quarter (1.7 percent annual); the weighted median rose by 0.4 percent (1.3 percent annual) and the CPI less volatile items rose by 0.3 percent (1.6 percent annual). Overall, underlying inflation rose by 0.4 percent in the quarter and by 1.53 percent over the year – a record low.</p>
<p>The Bureau of Statistics noted: “The most significant price rises this quarter are medical and hospital services (+4.2 percent), automotive fuel (+5.9 percent), tobacco (+2.1 percent) and new dwelling purchase by owner- occupiers (+0.9 percent). The most significant offsetting price falls this quarter are domestic holiday travel and accommodation (-3.7 percent), motor vehicles (-1.3 percent) and telecommunication equipment and services (- 1.5 percent).”</p>
<p>Prices of tradables rose by 0.6 percent in the June quarter with higher petrol prices offsetting low car prices. The tradables component of consumer prices was unchanged in the year to June.</p>
<p>Prices of non-tradables rose by 0.4 percent in the June quarter. Price increases were recorded for new dwelling purchase and hospital and medical services. The most significant offsetting fall was for domestic holiday travel and accommodation. Non-tradables prices rose by 1.6 percent in the year to June. Tradable goods are those items whose prices are largely determined on the world market. Non-tradable prices are more affected by domestic economic conditions.</p>
<p><a href="/images/2016/07/28/Screen%20Shot%202016-07-28%20at%208.23.35%20AM.png" target="_blank">Click to enlarge</a></p>
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<p><span>Why is the data important? </span></p>
The Consumer Price Index (CPI) is regarded as Australia’s premier measure of inflation. The CPI is published quarterly and measures price changes for a ‘basket’ of goods and services that dominate expenditure of metropolitan households. The “All Groups” index is the main focus, but other inflation measures are also published such as so-called ‘underlying’ measures. These include measures that abstract from price changes in volatile price items such as fresh food and petrol.<br><p>The Reserve Bank aims to keep the headline inflation rate between 2-3 percent over an economic cycle. If inflation is high and expected to rise, the Reserve Bank may elect to raise interest rates in order to constrain price pressures. Conversely, if inflation is low and expected to remain low, the Reserve Bank may elect to cut interest rates if it believes the growth pace of the economy is in need of strengthening.</p>
<p>What are the implications?</p>
<p>CommSec expects the Reserve Bank to cut the cash rate next week by 25 basis points or a quarter of a percent to 1.75 percent.</p>
<p><a href="/images/2016/07/28/Screen%20Shot%202016-07-28%20at%208.24.41%20AM.png" target="_blank">Click to enlarge</a></p>
<p><img src="/images/2016/07/28/Screen%20Shot%202016-07-28%20at%208.24.41%20AM.png" alt=""></p>
At the Reserve Bank website, four measures of inflation are represented – the headline rate of inflation and three underlying measures. All four are important. The headline inflation rate is at 17-year lows. The average underlying rate is 1.53 percent – the lowest result in data extending back to 1983. It is clear that little stands in the way of the Reserve Bank cutting rates again.</div>
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<div class="column">There are no inflationary pressures. Businesses will need to continue to look at cost and productivity savings to keep prices low or drive prices even lower. </div>
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<p> <em>Craig James is the chief economist at <a href="https://www.comsec.com.au/default.aspx" target="_blank">CommSec</a>.</em></p>
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jchancellor-FAypfDUnLy

Little in the way of the Reserve Bank cutting rates again: CommSec's Craig James

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<div class="column">GUEST OBSERVER</div>
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<div class="column">Low and falling investment yields from most major asset classes point to a constrained medium term return outlook. For a diversified mix of assets, this has now fallen to around 6.9 percent on our projections.</div>
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<br>For investors the key is to: have realistic return expectations; allow that inflation is also low so real returns aren’t down as much; focus on asset allocation; and focus on assets with decent &amp; sustainable income.</div>
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<div class="column">Introduction</div>
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<div class="column">While the high inflation of the 1970s and early 1980s was bad for investment returns at the time, it left a legacy of very high investment yields which helped set the scene for high investment returns through the 1980s and 1990s. Back in the early 1980s the RBA's "cash rate" was averaging around 14%, 3 year bank term deposit rates were around 12%, 10 year bond yields were around 13.5%, commercial and residential property yields were running around 8-9% and dividend yields on shares were around 6.5% in Australia and 5% globally. Such yields meant investments were already providing very high cash income. So for assets like property or shares only modest capital growth was necessary to give good returns. As a result, back then the medium term (5-10 year) return potential from investing was solid. In fact most assets had spectacular returns in the 1980s and 1990s. Australian superannuation funds saw returns average 14.1% pa in nominal terms and 9.4% pa in real terms between 1982 and 1999 (after taxes and fees). </div>
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<p>But since the early 1980s the starting point in terms of investment yields has been moving progressively lower, resulting in slowing 10 year average nominal and real returns for superannuation funds as seen the chart above. Today the RBA cash rate is just 1.5 percent, 3 year bank term deposit rates are just 2.6-3 percent, 10 year bond yields are just 1.9 percent, gross residential property yields are around 3 percent and while dividend yields are still around 6 percent for Australian shares (with franking credits) they are around 2.5 percent for global shares. This note looks at the medium term return potential from major assets and the implications for investors. </p>
<p>Potential return drivers</p>
<p>In getting a handle on potential medium term returns from an asset class the key is its starting point valuation. For example, if current yields – say bond yields and dividend yields – are lower than “normal” then this will likely constrain returns relative to the past. Investment returns have two components; capital growth, and yield (or income). The yield is the most secure component and generally speaking, when you start your investment the higher it is the better. So our approach to assessing medium term return potential is to start with current yields for each asset class and apply simple and consistent assumptions regarding capital growth. We prefer to avoid a reliance on forecasting and to keep the analysis as simple as possible. Complicated adjustments just lead to compounding forecasting errors. </p>
<p>For equities, a simple model of current dividend yields plus trend nominal GDP growth (as a proxy for earnings and capital growth) does a good job of predicting medium term returns. This approach allows for current valuations (via the yield) but avoids getting too complicated.1 The next chart shows this approach applied to US equities, where it can be seen to broadly track big secular swings in returns. </p>
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<p> <a href="/images/2016/08/16/Screen%20Shot%202016-08-17%20at%208.17.56%20AM.png" target="_blank">Click to enlarge</a></p>
<p><span><img src="/images/2016/08/16/Screen%20Shot%202016-08-17%20at%208.17.56%20AM.png" alt=""></span></p>
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<p>For property, we use current rental yields and likely trend inflation as a proxy for rental and capital growth.</p>
<p>For unlisted infrastructure, we use current average yields and capital growth just ahead of inflation. </p>
<p>For bonds, the best predictor of future medium term returns is the current bond yield. If a 10 year bond is held to maturity its initial yield will be its return over 10 years. The close relationship between 10 year bond yields and subsequent returns from bonds is clear in the next chart. </p>
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<p><a href="/images/2016/08/16/Screen%20Shot%202016-08-17%20at%208.19.43%20AM.png" target="_blank"><span>Click to enlarge</span></a></p>
<p><span><img src="/images/2016/08/16/Screen%20Shot%202016-08-17%20at%208.19.43%20AM.png" alt=""></span></p>
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<p>Projections for medium term returns</p>
<p>Return projections using this approach are shown in the next table. The second column shows each asset’s current income yield, the third shows their 5-10 year growth potential, and the final column their total return potential. Note that:</p>
<p>We assume central banks average around or just below their inflation targets, e.g. 2.5 percent in Australia &amp; 2 percent in the US.</p>
<p>For Australia we have adopted a relatively conservative growth assumption below nominal GDP growth potential reflecting the headwind from weak commodity prices &amp; the impact of this on resource sector profits &amp; sales growth.</p>
<p>We allow for forward points in the return projections for global assets based around current market pricing – which adds 1.8 percent to the return from world equities.</p>
<p>The Australian cash rate is assumed to average 2.75 percent over the medium term. Cash is one asset where the current yield is of no value in assessing the asset’s medium term return potential because the maturity is so short. So we assume a medium term average. Normally for cash this would be around a country’s potential nominal growth rate, but we have adjusted for higher than normal bank lending rates relative to the cash rate and higher household debt to income ratios which have pulled down the neutral cash rate.</p>
<p>Combining the return projections for each asset indicates that the implied return for a diversified growth mix of assets has now fallen to 6.9 percent pa and is shown in the final row. </p>
<p><a href="/images/2016/08/16/Screen%20Shot%202016-08-17%20at%208.21.50%20AM.png" target="_blank">Click to enlarge</a></p>
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<p>Megatrends influencing the growth outlook</p>
<p>Several themes are allowed for in our projections: slower growth in household debt; the backlash against economic rationalist policies of globalisation, deregulation and small government; rising geopolitical tensions; aging and slowing populations; low commodity prices; technological innovation &amp; automation; the Asian ascendancy &amp; China’s growing middle class; rising environmental awareness; &amp; the energy revolution. Most of these are constraining nominal growth and hence investor returns. However, technological innovation is positive for profits and some of these point to inflation bottoming. (See “Megatrends ”, Oliver’s Insights, July 2016. </p>
<p>Key things to note </p>
<p>Several things are worth noting from these projections. </p>
<p>The medium term return potential using this approach continues to soften largely reflecting the rally in most assets of the last few years which has pushed investment yields lower. Projected returns using this approach for a diversified growth mix of assets has fallen from 10.3% pa at the low point of the GFC in March 2009 to 6.9% now. </p>
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<p><a href="/images/2016/08/17/Screen%20Shot%202016-08-17%20at%208.25.44%20AM.png" target="_blank"><span>Click to enlarge</span></a></p>
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<em><em><a href="https://www.propertyobserver.com.au/https://plus.google.com/110172465327488162875?rel=author" target="_blank"></a></em></em>
<p>The starting point for returns today is far less favourable than when the last secular bull market in shares and bonds started in 1982, due to much lower yields.</p>
<em><em><a href="https://www.propertyobserver.com.au/https://plus.google.com/110172465327488162875?rel=author" target="_blank"></a></em></em>
<p>Government bonds offer low return potential thanks to ultra low bond yields.</p>
<em><em><a href="https://www.propertyobserver.com.au/https://plus.google.com/110172465327488162875?rel=author" target="_blank"></a></em></em>
<p>Unlisted commercial property and infrastructure continue to come out well, reflecting their relatively high yields.</p>
<em><em><a href="https://www.propertyobserver.com.au/https://plus.google.com/110172465327488162875?rel=author" target="_blank"></a></em></em>
<p>Australian shares stack up well on the basis of yield, but it’s still hard to beat Asian shares for growth potential.</p>
<em><em><a href="https://www.propertyobserver.com.au/https://plus.google.com/110172465327488162875?rel=author" target="_blank"></a></em></em>
<p>The downside risks to our medium term return projections are referred to endlessly by financial commentators: namely that the world is plunged into another recession or that investment yields are pushed up to more normal levels causing large capital losses. The upside risks are (always) less obvious but could occur if global growth improves but inflation remains low which could see a continuing search for yield further pushing up capital values.</p>
<em><em><a href="https://www.propertyobserver.com.au/https://plus.google.com/110172465327488162875?rel=author" target="_blank"></a></em></em>
<p>Implications for investors</p>
<em><em><a href="https://www.propertyobserver.com.au/https://plus.google.com/110172465327488162875?rel=author" target="_blank"></a></em></em>
<p>There are several implications for investors:</p>
<em><em><a href="https://www.propertyobserver.com.au/https://plus.google.com/110172465327488162875?rel=author" target="_blank"></a></em></em>
<p>First, have reasonable return expectations. The combinatinofof low investment yields &amp; constrained GDP growth indicate it’s not reasonable to expect sustained double digit returns. In fact, the decline in the rolling 10 year moving average of superannuation fund returns (first chart) indicates we have been in a lower return world for many years.</p>
<em><em><a href="https://www.propertyobserver.com.au/https://plus.google.com/110172465327488162875?rel=author" target="_blank"></a></em></em>
<p>Second, allow that this partly reflects very low inflation. Real returns haven’t fallen as much and are still reasonable. </p>
<em><em><a href="https://www.propertyobserver.com.au/https://plus.google.com/110172465327488162875?rel=author" target="_blank"></a></em></em>
<p>Third, using a dynamic approach to asset allocation makes sense as a way to enhance returns when the return potential from investment markets is constrained. This is likely to be enhanced by continued bouts of volatility.</p>
<em><em><a href="https://www.propertyobserver.com.au/https://plus.google.com/110172465327488162875?rel=author" target="_blank"></a></em></em>
<p>Finally, focus on assets providing decent sustainable income as they provide confidence regarding future returns, eg; commercial property and infrastructure. </p>
<em><a href="https://www.propertyobserver.com.au/https://plus.google.com/110172465327488162875?rel=author" target="_blank"><br>SHANE OLIVER</a> is head of investment strategy and economics and chief economist at <a href="https://www.ampcapital.com.au/home" target="_blank">AMP Capital</a> and is responsible for AMP Capital's diversified investment funds.</em>
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The constrained medium term investment return outlook: AMP's Shane Oliver

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<p>GUEST OBSERVER</p>
<p>New weights could lower the pace of headline inflation by up to 0.4ppt (–0.3ppt core) by end 2018.</p>
<p>Every five years or so the ABS revises the weights in the CPI based on its detailed household expenditure survey. This brings the CPI up-to-date with the latest spending patterns associated with changing technology and individual preferences as well as correcting a substitution bias that emerges over time as spending tends to rise (fall) for items where relative prices have declined (risen).</p>
<p>There is also a drift in the share of the expenditure classes in the CPI towards those that are rising more rapidly and away from the expenditure classes where prices are falling. </p>
<p>The ABS has estimated that historically, this substitution bias is worth around ¼ of a percentage point on the annual rate of inflation at each re-weighting. </p>
<p>The ABS is set to re-weight the CPI (the 17th CPI) with the release of the 2017 December Quarter CPI. However, we concur with a recent comment from RBA that looking at the historical impact of re-weighting the CPI may not provide a reliable guide to the upcoming re-weighting. </p>
<p>Using our bottom-up approach for forecasting inflation out to 2018 and applying our estimate of the revision to the weights we find that our headline inflation forecast is 0.4ppt lower by the December quarter 2018 compared to our existing forecast. We also found that the re-weighting lowers our core inflation forecast by 0.3ppt. </p>
<p>A big part of this revision to our forecast is due to the lowering of the weight for tobacco in the CPI from our implicit estimate for December 2017 (before re-weighting) of 4.2% to 2.5%. At the 2011 reweighting tobacco’s weight was 2.3%.</p>
<p>As our revised weights are estimated from the best information we have on hand we will do another update post the release of the latest Household Expenditure Survey. However, as we can’t fully replicate the ABS’s methodology will not complete a formal review of our forecasts until the ABS releases the new weights.   </p>
<p>Until then what we can say is that the downside risk to the inflation outlook is somewhat greater than the historical estimate of 0.2ppt and could be as large as 0.4ppt.</p>
<p class="p1"><span class="s1">Justin Smirk is ‎senior economist, Westpac Group and can be contacted <a href="https://www.westpac.com.au/about-westpac/westpac-group/"><span class="s2">here</span></a>.</span></p>
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Upcoming CPI re-weighting to lower inflation: Justin Smirk

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<p class="x_MsoListParagraph">GUEST OBSERVER</p>
<p class="x_MsoListParagraph">September quarter inflation was slightly higher than expected at 0.7 percent quarter on quarter or 1.3 percent year on year (up from 1 percent yoy).</p>
<p class="x_MsoListParagraph">However, this was driven by sharp price rises for only a handful of items with fruit and vegetables up 11.6 percent/qoq, electricity prices up 5.4 percent/qoq, tobacco prices up 2.3 percent/qoq and property rates and charges up 4 percent/qoq.</p>
<p class="x_MsoListParagraph">Underlying inflation was actually lower than expected at 0.3 percent/qoq or 1.5 percent/yoy. Deflationary pressures remain significant across a range of areas with clothing prices up only 1.2 percent/yoy, rents up just 0.7 percent/yoy, household appliances up only 1.3 percent/yoy, motor vehicle prices down 1.6 percent/yoy and ongoing weakness in prices for recreation and culture (up 0.6 percent/yoy). </p>
<p class="x_MsoListParagraph">Both tradeable and non-tradable inflation remain weak at 0.7 percent/yoy and 1.7 percent/yoy respectively.</p>
<p class="x_MsoNormal"><a href="/images/2016/10/27/image004.png" target="_blank">Click to enlarge </a></p>
<p class="x_MsoNormal"><img src="/images/2016/10/27/image004.png" alt=""></p>
<p class="x_MsoNormal">Source: ABS, AMP Capital</p>
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<p class="x_MsoNormal"><strong>Implications for the RBA </strong></p>
<p class="x_MsoNormal">While it’s a close call, the September quarter inflation result was probably not low enough overall to trigger another rate cut from the RBA at next week’s Board meeting. Both headline and underlying inflation are in line with the RBA’s inflation forecasts and the rise in headline inflation may reduce the short term downside threat to inflation expectations and at the same time economic growth in Australia looks reasonable with the worst of the mining investment slump behind us and a rise in commodity prices set to boost growth in national income. As such, the RBA can afford to be patient in waiting for inflation to head back to target and thereby avoid the risk of adding to financial instability (read a further acceleration in Sydney and Melbourne home price gains) with another rate cut for now.</p>
<p class="x_MsoNormal">However, inflation is still very low, it’s not clear that it has bottomed yet and the $A remains uncomfortably high so it’s premature to close the door on another rate cut.</p>
<p class="x_MsoNormal">Overall, we think that the RBA will leave rates on hold when it meets again next week, but that another cut (more likely next year) cannot be ruled out.</p>
<p class="x_MsoNormal"><em><span><a href="https://www.propertyobserver.com.au/https://plus.google.com/110172465327488162875?rel=author" target="_blank">SHANE OLIVER</a></span> is head of investment strategy and economics and chief economist at <a href="https://www.ampcapital.com.au/home" target="_blank">AMP Capital</a> and is responsible for AMP Capital's diversified investment funds.</em></p>
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Another low reading on Australian inflation, but probably not enough to push the RBA to cut again next week

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<p><img src="https://counter.theconversation.edu.au/content/64265/count.gif" alt="The Conversation" width="1" height="1"></p>
<p>GUEST OBSERVER</p>
<p>In the revolving door of economic ideas, the old can be suddenly new again. Independent Senator Nick Xenophon resurrected one such idea this week.</p>
<p>He said the Reserve Bank of Australia should replace its inflation target of 2-3 percent per annum with a target of nominal GDP growth of around 5.5 percent per annum.</p>
<p>This is more than just an armchair economics debate – it could seriously affect all households and businesses in Australia.</p>
<p>First, a short primer. The RBA determines the general level of interest rates that we all pay on loans and earn on deposits. It has no legislative power to directly set rates, but it might as well have because its indirect control is so precise via other legislative requirements on banks.</p>
<p>The RBA’s aim is to restrict inflation – the average rate of increase in prices – to a band between 2 and 3 percent over a period of years between economic booms and downturns. Why 2-3 percent? Because too much inflation is bad, and so is too little inflation. 2-3 percent is the sweet spot.</p>
<p>A higher rate of inflation (remember it’s an average) means some prices are going up more than others creating uncertainty about future costs and selling prices, which discourages investment expenditure. Higher inflation also encourages speculative investments in housing and other assets, which can create speculative bubbles. And as we know, bubbles can burst.</p>
<p>Inflation that is too low, say 0-1 percent, means some businesses are selling at prices that are stagnant or falling, but their debts are not falling. That leads to difficulty in meeting debt repayments. So if the RBA thinks inflation is heading up beyond its target, it will raise interest rates to stop households and businesses borrowing and spending, which reduces pressure on prices. If it thinks inflation is too low it will cut rates to encourage us all to borrow and spend.</p>
<p>Now back to Xenophon’s idea. He, and some respected economistsbefore him, think inflation is the wrong target. What if, they argue, inflation is going up only because energy prices are going up? High energy prices can’t be good news for businesses and households. So why would the RBA want to make life even harder by raising interest rates to lower inflation? Madness they say. Better to target the sum of the inflation rate plus the growth in national output of goods and services (GDP), what is called nominal GDP growth.</p>
<p>So if inflation is going up but output is going down because of the depressing effect of high energy prices, nominal GDP would be flat and the RBA would do nothing, neither contracting nor expanding nominal GDP growth – the right policy.</p>
<p>Economists are split on this and have been for years. In August 2011 The Economist newspaper decided it was a good idea, and then three months later published an article against the idea. This is not unusual in economic debates incidentally – many economic “principles” are in fact contested, as is the case for most social sciences.</p>
<p>One big problem with Xenophon’s idea is that the theory does not fit the times. It is not the right policy for today.</p>
<p>Energy prices are not going up; they have been falling and are now flat. Yes, electricity prices have been going through the roof in South Australia and to a lesser extent elsewhere. But oil prices have been falling or flat over recent years, and this has a more pervasive effect than government bungling of the electricity market.</p>
<p>So output growth and inflation are not moving in opposite directions – both have fallen in recent years. Inflation is now below the bottom of the RBA’s target zone of 2-3 percent on any of the alternative measures.</p>
<p>The RBA, along with most central banks of advanced countries, would actually like to see more inflation, not less. Annual output growth is struggling to reach 3 percent, which is below the long run average of 3.5 percent. Hence nominal GDP growth is below the 5.5 percent long-run average that Xenophon would target. So whether the RBA targets inflation or nominal GDP growth doesn’t matter – the policy would be the same – that is, stimulate spending by lowering interest rates, which is exactly what it has been doing.</p>
<p>Another downside is that although nominal GDP growth would be more stable, inflation would tend to be more volatile. Inflation could jump up and down, but as long as output growth moved in the opposite direction the RBA would do nothing to dampen the volatility in inflation. Volatile inflation increases the uncertainty about future prices, which inhibits investment spending by firms and households.</p>
<p>A bigger problem with the RBA’s inflation target that would not be resolved by adopting a nominal GDP target, is that the inflation target only refers to prices of goods and services – it ignores asset price inflation. The rapid rise in house prices in Sydney and Melbourne in recent years is a potentially serious problem that has been essentially ignored by the RBA. A better idea than nominal GDP targeting would be to include asset prices as well as the prices of goods and services in its inflation target.</p>
<p>And finally, if a nominal GDP target is such a good idea, then why is no country doing it? It is within the charter of most central banks to target nominal GDP growth instead of inflation, but none are, at least not formally.</p>
<p>Many central banks look at wider economic conditions as well as inflation. They will temporarily tolerate higher inflation when output growth, but the inflation rate remains their primary target. This flexibility seems reasonable, keeping inflation as the primary target. We would be the first to experiment with a strict nominal GDP target. Do we really want our Reserve Bank to be the world’s guinea pig?</p>
<p><em><span class="fn author-name">Ross Guest is p</span>rofessor of Economics and National Senior Teaching Fellow, Griffith University and author for The Conversation. He can be contacted <a href="https://theconversation.com/profiles/ross-guest-13155" target="_blank">here</a>.</em></p>
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Why some economists think the RBA should drop its inflation target

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<p>GUEST OBSERVER</p>
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<p><span>The RBA has broadly left its near-term growth forecasts intact while medium-term projections are unchanged. </span></p>
<p><span> </span><span>Inflation forecasts are untouched and core inflation is expected to gradually rise from here.</span></p>
<p><span>The RBA have a soft downward trajectory for the unemployment rate that broadly tracks around 5 3⁄4 percent.</span></p>
<p><span> </span><span>We have the RBA cash rate on hold at 1.5 percent throughout 2017 and into 2018.</span></p>
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<p><span>The RBA’s </span><span>updated forecasts haven</span><span>’</span><span>t shifted the monetary policy dial in the slightest. The Bank has forecast decent growth outcomes over the next few years. And while core inflation is not expected to get back to target until 2018, it is forecast to rise gradually. </span></p>
<p><span>The RBA is, however, more confident that its forecasts will be achieved. We think that the Bank retains its neutral bias despite there being no forward guidance in </span><span>today’s </span><span>Statement on Monetary Policy (SMP).</span></p>
<p><a href="https://www.propertyobserver.com.au/images/2017/05/08/Screen%20Shot%202017-05-08%20at%208.15.15%20AM.png" target="_blank"><span>Click to enlarge</span></a></p>
<p><span><img src="https://www.urban.com.au/images/2017/05/08/Screen%20Shot%202017-05-08%20at%208.15.15%20AM.png" alt=""></span></p>
<p> </p>
<p><span>Looking at the Bank’s through the year forecasts im</span><span>plies that the pace of growth picks up from 2 percent/pa mid-2017 to an above-trend 3 percent by year end. The economy is forecast to be growing by a strong 3 1⁄4 percent by mid-2018. LNG production, infrastructure spend and a lift in non-mining investment are expected to push growth higher. </span></p>
<p><span>The RBA expects LNG exports to add 1⁄2ppt to GDP growth in both 2017 and 2018 in QII. The Bank has indicated that Cyclone Debbie will negatively impact on coal exports. But judging from the RBA</span><span>’</span><span>s growth forecasts the impact has not been severe enough to revise down GDP estimates. The Australian economy would be deemed to be in good shape if the RBA</span><span>’</span><span>s growth outcomes can be achieved. While we think they are possible, they look a best case scenario and the risk is that output growth undershoots </span><span>the Bank’s forecasts. </span><span>At this stage, QI GDP growth is shaping up as a soft print. </span></p>
<p><span>The RBA expects household income to grow, </span><span>“</span><span>at a similar rate to consumption, implying little change in the household saving ratio.</span><span>” </span><span>Here we note that the savings rate has been trending lower since dwelling price growth lifted. The fall in the savings rate has supported consumption growth in the face of weak wages growth.</span></p>
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<p> </p>
<p><span>The Bank</span><span>’</span><span>s assessment on the labour market is best characterised as temperate. The RBA sees employment growth as </span><span>“</span><span>moderate</span><span>” </span><span>over the next six months but expects it to pick up to around its </span><span>“</span><span>long run</span><span>” </span><span>average beyond that. The GDP and employment growth forecasts are reconciled by the big contribution to growth that will come from LNG production which is not labour intensive. </span></p>
<p><span>A possible decline in underemployment also explains the disparity between GDP and employment forecasts (i.e. growth in hours worked could be stronger than employment growth if some part-time employees find additional work). The unemployment rate is forecast to be around 5 3⁄4 percent over the forecast period but with a very mild downward trend. </span></p>
<p><span>On wages, the RBA expects growth to remain steady over the next year before picking up over 2018 and 2019, although, </span><span>“</span><span>at a slightly slower pace than had been forecast in February.</span><span>” </span><span>Inflation forecasts are unchanged from February. Core inflation is expected to rise gradually but is unlikely to get back to target until 2018. We agree.</span></p>
<p><a href="https://www.propertyobserver.com.au/images/2017/05/08/Screen%20Shot%202017-05-08%20at%208.18.00%20AM.png" target="_blank"><span>Click to enlarge</span></a></p>
<p><span><img src="https://www.urban.com.au/images/2017/05/08/Screen%20Shot%202017-05-08%20at%208.18.00%20AM.png" alt=""></span></p>
<p> </p>
<p><span>It sounds like a broken record now, but rate cuts are off the table unless the housing market falters or the unemployment rate materially rises. We think that the inflation prints over 2017 will take a back seat to developments in the labour and housing markets.</span></p>
<p><span> As such, our monetary policy call has the RBA on hold in 2017 and well into 2018. The risk, however, lies with another cut given weak wages growth, below target core inflation and an expected further downturn in hard commodity prices. </span></p>
<p><span><em>Gareth Aird is economist at Commonwealth Bank and can be contacted </em><a href="https://www.propertyobserver.com.au/https://au.linkedin.com/pub/gareth-aird/14/790/905"><span class="s2"><em>here</em></span></a><em>.</em></span></p>
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Growth and inflation forecasts broadly unchanged: Gareth Aird

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<p>GUEST OBSERVER</p>
<p>With the RBA now expecting underlying inflation to move into the middle of the target band by the end of the forecast period, the Bank seems firmly on hold. </p>
<p>The Bank sees wages growth to be broadly unchanged this year, as some of the factors which have been holding down wages dissipate, after which it picks up gradually over 2018 and 2019. </p>
<p> We continue to see the cash rate on hold at 1.5 percent. </p>
<p><a href="https://www.propertyobserver.com.au/images/2017/02/10/Screen%20Shot%202017-02-10%20at%201.49.05%20PM.png" target="_blank">Click to enlarge</a></p>
<p><img src="https://www.urban.com.au/images/2017/02/10/Screen%20Shot%202017-02-10%20at%201.49.05%20PM.png" alt=""></p>
<p>DETAILS</p>
<p>The rising profile for underlying inflation is significant. The new forecast profile for underlying inflation shows inflation running between 1½-2½ percent until the end of 2018, after which it ticks up to 2-3 percent by mid-2019. While this is still a solid two years away it suggests that the Bank is more confident that inflation will eventually pick up. The Bank notes that some of the factors that have been holding down inflation, like the falling terms of trade and the decline in mining employment, are dissipating and also cites “evidence from surveys and liaison with firms suggesting that wage growth is unlikely to ease further”. </p>
<p>There were significant downward revisions to GDP growth in the near term and small downward revisions further out but we would not read too much into these. That is, the downgrade to the near term forecasts reflects base effects from the (temporary) weakness in Q3 GDP, while the small downgrade to the further out forecasts to 2¾-3¾, rather than the previous 3-4, in our view seems a much more achievable estimate. The Bank noted that it has lifted its forecasts for trading partner growth and the terms of trade, but lowered its estimates for consumer spending and employment growth.</p>
<p>Interestingly, the RBA published the unemployment rate forecasts in its table for the first time. It expects the unemployment rate at 5-6 percent over the forecast horizon, broadly similar to the previous forecasts included in its chart.</p>
<p>The RBA seems accepting of the level of the AUD. The currency hardly rated a mention in today’s SoMP which, together with Governor Lowe’s comments last night, suggests that at current levels the RBA sees the dollar as close to fair value.</p>
<p><em>Felicity Emmett co-head of Australian economics, ANZ Research and can be contacted <a href="https://www.anz.com/corporate/research/" target="_blank">here</a>.</em></p>
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Rising profile for underlying inflation is significant: ANZ's Felicity Emmett

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<p>GUEST OBSERVER</p>
<p>The Reserve Bank hasn’t materially changed inflation forecasts but it has trimmed economic forecasts over the near-term. Economic growth is now seen at 1.5-2.5 percent in June 2017, around one percentage point lower than previous forecasts.</p>
<p>Inflation is expected to hold between 1.5-2.5 percent over the forecast period – below or at the low end of the 2-3 percent target band.</p>
<p>Home loans: The number of loans (commitments) for budding home owners (owner-occupiers) rose by 0.4 percent in December after rising by 1.3 percent in November. The value of loans (owner occupier and investment) rose by 0.4 percent in December after rising by 2.2 percent in November.</p>
<p>Owner-occupier loans rose by 1.3 percent but investment loans fell by 1 percent.</p>
<p>What does it all mean?</p>
<p>The latest Monetary Policy statement has given the Reserve Bank the opportunity to flesh out how the economy is tracking. And it seems like the Central Bank is in the glass half-full camp. Policymakers have updated economic growth and inflation forecasts and it is clear that growth remains relatively sound.</p>
<p>Interestingly inflation is expected to remain below or at the low end of the Reserve Bank 2-3 percent target band over the next two years. Essentially the assumption of subdued inflation is despite the potential inflationary impact of higher commodity prices - which suggests a lack of inflation across the rest of the economy.</p>
<p>The assumption of low inflation and stronger economic growth over time suggests that interest rates remain on hold.</p>
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<br>Importantly given that near-term growth forecasts have been downgraded and now expected to hold between 1.5- 2.5 percent, it is clear the central bank is prepared for a degree of softness across the domestic economy. Interestingly when coupled with subdued inflation it suggests policymakers will keep the door open to provide further stimulus. However it should be made clear that the central bank is essentially holding a neutral policy stance.<br><p>The economy was essentially lacklustre throughput the majority of 2016 despite unemployment drifting to 3-year lows. However the anecdotal evidence across the economy suggest that activity levels are now lifting.</p>
<p> In that context the latest housing finance data is encouraging. Not only did the number of overall housing finance commitments lift for the second straight month, but it was driven by owner-occupier loans rather than investment loans. Overall the Reserve Bank is correct in its view that conditions in the housing market are very mixed.</p>
<p>What do the figures show?</p>
<p>Housing finance - number</p>
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<li>The number of loans (commitments) for budding home owners (owner-occupiers) rose by 0.4 percent in December after rising by 1.3 percent in November.</li>
<li>Excluding the refinancing of dwellings, the number of loans was up by 2.4 percent.</li>
<li>  The number of new home loans was down by 4.4 per cent on a year ago.</li>
<li>  Loans by owner-occupiers for the construction of homes fell by 0.3 per cent in December.</li>
<li>  Loans to buy newly-erected dwellings rose by 3.2 per cent.</li>
<li>  Loans for the purchase of established dwellings (excluding refinancing) rose by 0.3 per cent.</li>
<li>  The number of refinancing transactions fell by 3.5 per cent.</li>
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<p>Lending across states/territories: NSW (+1.5 percent); Victoria (+0.8 percent); Queensland (-1.3 percent); South Australia (-1.9 percent), Western Australia (-2.7 percent); Tasmania (-2.7 percent); Northern Territory (+0.5 percent); ACT (6.3 percent).</p>
<p>Housing finance - value</p>
The value of new housing commitments (owner occupier and investment) rose by 0.4 percent in December after rising by 2.2 percent in November. Owner-occupier loans rose by 1.3 percent but investment loans fell by 1 percent.<br><p>The value of loans by owner-occupiers and investors to build new homes fell by 1 percent in December after rising by 5 percent in November. The value of loans to build new homes fell from $3.1 billion to $2.74 billion in December.</p>
<p>Housing finance – other statistics</p>
<p>The proportion of first-time buyers in the home loan market held steady at 13.8 percent in December (long-term average 19.4 percent).</p>
<p>The proportion of fixed rate loans rose from 12.5 percent to 14.6 percent in December – a seven month high. And the average home loan across Australia stood at $375,800 in December, down 0.8 percent in the month but up 0.5 percent on a year ago.</p>
<p>Key take-aways from the Reserve Bank report</p>
<p> Below are our key “take-aways” from the Reserve Bank’s latest quarterly review.</p>
“Inflation is expected to increase as the effects of some factors that have been weighing on domestic cost pressures dissipate”(p3)</div>
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<br>“Headline inflation is expected to pick up to 2 per cent in early 2017. The increase in underlying inflation is likely to be gradual. These forecasts are little changed from those published in the November Statement on Monetary Policy” (p3)</div>
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<br>“Wage growth is forecast to increase only gradually” (p3)<br><p>“ there has been some evidence from surveys and liaison with firms suggesting that wage growth is unlikely to ease further.” (p3)</p>
  “Overall conditions in the established housing market have strengthened further, although there is significant variation across the country.” (p2)</div>
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<br>  “The global economy entered 2017 with more momentum than earlier expected.” (p1)</div>
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<br>  “Global inflationary pressures are somewhat stronger than they have been for some time,” (p1)</div>
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<br>  “ real GDP looks to have increased in the December quarter. Beyond that, the outlook for the domestic economy is little changed from three months ago and the ongoing adjustment to the end of the mining investment boom is expected to continue.” (p2)<br><p>  “Real GDP declined in the September quarter, a significantly weaker outcome than was anticipated. Some of the decline can be attributed to disruptions to coal supply and bad weather affecting construction activity.” (p1) </p>
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<div class="column">“Although investor activity is currently quite strong, at least in Sydney and Melbourne, history shows that sentiment can turn quickly, especially if prices start to fall.” (p62)</div>
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<br>  “The forecast for consumption growth has been adjusted lower and implies a stable saving ratio over the forecast period, rather than declining, as previously assumed.” (p61)</div>
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<br>  “The unemployment rate is expected to edge lower over the forecast period, suggesting only a modest reduction in the degree of spare capacity in the labour market from current levels.” (p58)</div>
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<br>  “ exports of Australian goods and services in aggregate are forecast to continue growing at a solid pace.) (p58)</div>
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<br>  “Given the stronger tone of more recent indicators, consumption growth is expected to be a little stronger than in mid 2016 over the forecast period.” (p57)</div>
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<br>  “GDP growth is forecast to increase to 21⁄2–31⁄2 per cent in late 2017, and to be above potential for most of the forecast period.” (p57)</div>
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<br>  “Some of the factors weighing on reported GDP growth in the September quarter were temporary and have not materially affected the outlook for growth.” (p56)</div>
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<br>“While considerable uncertainty remains about the economic policies of the new US administration, reductions in personal and corporate taxes are likely.”</div>
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<div class="column">“However, there is a rising risk that more restrictive and protectionist trade and immigration policies under the new administration could harm global growth prospects.” (p55)</div>
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<div class="column">  “A significant portion of the increase in investor credit growth is also likely to reflect the extension of credit to investors settling the payment of newly completed apartments that were purchased off the plan at an earlier time.” (p46)<br></div>
<div class="column"> “More recently, overall debt funding costs (by major banks) are estimated to have been stable, despite a little upward pressure from the increasing share and cost of long-term debt and deposit funding.” (p43)<br><p>  “Much of the apartment construction is geographically concentrated, particularly in inner-city Melbourne and Brisbane. This increases the chance that (localised) oversupply could develop, and would exacerbate the effect on local area prices if that were to occur.” (p37)</p>
<p>What is the importance of the economic data?</p>
Housing Finance data is produced monthly by the Bureau of Statistics and shows commitments by lenders, such as banks, to provide finance for housing purposes. The lending figures relate to those looking to buy or build homes to live in as well as those seeking to buy or build homes for investment purposes. Generally people get their finance organised first, so the figures are regarded as a leading indicator on the housing market.<br><p>The Reserve Bank releases its Statement on Monetary Policy each quarter. The Statement is the Reserve Bank’s assessment of economic and financial conditions and also contains the latest inflation views. The Statement is crucial is assessing the short-term outlook for interest rates.</p>
<p>What are the implications for interest rates and investors?</p>
The rebalancing of the domestic economy away from mining investment will remain the trigger for interest rates, especially given that inflation is subdued and expected to remain at the low end of the 2-3 per cent target band. However a number of indicators make rate cuts look less likely than even six months ago – improved Chinese activity levels, a stronger terms of trade, a modest lift in domestic activity and the Reserve Bank view that inflation has bottomed.</div>
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<div class="column">The home finance market is not a driver of interest rates at present. The Reserve Bank won’t be lifting or cutting rates on the lending trends. But with borrowers now looking more carefully at the market, competition across lenders looks likely to heat up. </div>
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<div class="column"><em>Savanth Sebastian is an economist for <a href="https://www.commsec.com.au/" target="_blank">CommSec</a></em></div>
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RBA tinkers with growth forecasts: Savanth Sebastian

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<p><span>GUEST OBSERVER</span></p>
<p><span>Household spending can be divided into three broad categories, services, retail trade, and non-retail goods. Where households spend has implications for overall economic activity. </span></p>
<p><span>For example, spending in labour intensive services sectors, such as health, or restaurants, will typically have a larger impact on overall economic and jobs growth than spending on some retail goods, such as furniture and clothes, which are largely imported. In this note we look at the broad long- term trends in the three expenditure categories. </span></p>
<p><span>Retail trade share of household spending has stabilised</span></p>
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<p><span>The retail trade share of household spending was on a long term downward trend but looks to have stabilised</span><span>. In the early 1980’s </span><span>retail trade accounted for over 40% of household spending compared to 31% today. The main beneficiary has been the services sector. Households have increased their share of spending on services from around 50 percent in the earl</span><span>y 1980’s to around 60 percent now</span><span>. </span></p>
<p><span>The long run decline in the retail trade share of household spending reflects the fall in prices of retail goods relative to other goods and services. In volume terms, the retail trade share of total household spending has stayed very close to 30 percent </span><span>since the data began in the early 1980’s.</span></p>
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<p><span>However, for the last three years the retail trade share of household spending has been flat. With volumes also being broadly steady, this shows that that the discounting of retail goods relative to other goods and services has eased. </span></p>
<p><span>Part of the stabilisation of retail prices relative to services is due to the depreciation in the Australian dollar. This has helped to lift import prices in Aussie dollar terms. However </span><span>RBA research </span><span>shows that this lift has not been as large as would have been expected given the size of the depreciation. Increased competition is limiting the pass through from imported prices to sales prices. </span></p>
<p><span>It also reflects a sharp slowing in services inflation since late 2013. Services inflation has typically been higher than for inflation for goods. However, both are now running at an annual rate of just 1.5 percent over the year to September. Inflation of market based services, such as meals out and hair cuts, has slowed more sharply to an annual rate of just 0.9 percent over the year to September. </span></p>
<p><span>The slowing in services inflation, and inflation more generally, reflects a number of factors. Firstly there is spare capacity in the economy, which can be seen in the high rate of labour market underutilisation. Secondly, increased competition globally and advances in technology have reduced the pricing power in many markets.</span></p>
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<p><span>In a recent speech, RBA Governor Lowe spoke about how reduced pricing power was not just effecting the manufacturing sector, but service sectors too. Thirdly, job security fears have been heightened since the GFC. This means </span>that workers are less inclined to push for wage increases, in sectors where part- time work is replacing full-time permanent positions.</p>
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<p><span>But services share is still increasing </span></p>
<p><span>The share of household spending on services has increased over time. Spending on purely discretionary services, such as restaurants, accommodation and recreation, accounts for around 15% of household outlays. This share has been broadly stable over time. Contrary to popular perception, the share of spending on </span><span>“</span><span>meals out</span><span>” </span><span>has declined over time, now accounting for 5.2 percent of spending compared to 6.2 percent 30 years ago. </span></p>
<p><span>So the upward trend has been driven by an increasing share of spending on non-discretionary services, such as rent, health, education, transport and communications. These categories account for 45 percent of household spending, having increased from around 30 percent 30 years ago. The shift in spending reflects relatively stronger price increases for these services as well as a change in preferences towards these areas. </span></p>
<p><span>For example:</span></p>
<p>Insurance and other financial services – growth in this category is running at 6.5 percent over the year to June. As a share of housing spending, insurance and other financial services now accounts for 9.2 percent, compared to 8.4 percent three years ago.</p>
<p><a href="/images/2016/11/16/Screen%20Shot%202016-11-16%20at%208.35.15%20AM.png" target="_blank">Click to enlarge</a></p>
<p><img src="/images/2016/11/16/Screen%20Shot%202016-11-16%20at%208.35.15%20AM.png" alt=""></p>
<p>Growth in this category has been driven by an increase in the volume of spending. Excluding price effects, the proportion of spending on this category has also increased by a similar magnitude.</p>
<p>Consumers have shown a higher degree of caution around employment prospects in recent years. As a result they may be taking on a greater degree of insurance to guard against the loss of income, a decline in health or loss of other assets. There are also a larger number of products on offer.</p>
<p>Spending on health services rose by almost 10% over the year to June. The share of household spending continues to increase, accounting for around 5% compared to 4% ten years ago. The increase has been driven by both relatively strong price increases as well as an increase in volume of spending. The ageing population has also boosted spending on health and this trend will continue. A higher proportion of the population now has (subsidised) private health insurance which has boosted the number of elective procedures.</p>
<p>Education has also grown at an above average pace, with spending up 5.8% over the year. Education accounts for 4.7% of household spending compared to 3.5% 10 years ago. The increase in the share of spending is due to relatively strong price increases and also a larger volume of spending on this category. For example, a greater proportion of people are finishing year 12 and undertaking further education.</p>
<p>One category of discretionary services spending which has increased over time is overseas travel. As a share of household outlays, expenditure on travel has increased from 2.5 percent in the early 1980’s to around 3.7 percent now. The share of spending on flights has fallen as the relative cost has declined.</p>
<p>However outlays on overseas accommodation and other travel costs has increased.</p>
<p>Spending on non-retail goods is falling</p>
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<div class="column">The retail trade share of household spending has stabilised in recent years. And the services share continues to increase. This means the share of spending on non-retail goods has declined. </div>
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<br>In particular, the share of spending on vehicles and their maintenance has fallen by 1 percent point over the past three years. There has been a long run downtrend in spending on these categories with the share of households spending around currently 7 percent compared to a peak of 11 percent in the 1980s. This largely reflects price falls – the price deflator for vehicles has declined by 25% since late 2007, while the deflator for the maintenance of vehicles is 7 percent lower over the past three years. Vehicles are cheaper, more reliable and can be funded via mortgage redraws at a lower cost.</div>
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<br>Summary</div>
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<br>Changes in relative pricing, which have reduced the price of goods relative to services, have contributed to some very long run trends in household spending. Households have spent an increasing share on the consumption of services, while spending on retail and other goods has declined.</div>
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<br>However the good news for retailers is that their share of household spending has been stable in recent years. This reflects a lower Australian dollar, which has lifted the price of some retail goods. However it also reflects a fall in the price of other consumption goods, such as cars, and a slowing in services inflation.</div>
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<br>With plenty of spare capacity in the labour market, wages growth and non- tradeables inflation are likely to remain soft for many years. This means the relative price of services is likely to remain subdued. And the upward trend in the services share of household spending may flatten out. </div>
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<p><em>Kristina Clifton is economist, Commonwealth Bank, and can be contacted <a href="https://www.commbank.com.au" target="_blank">here</a>.</em></p>
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