Reserve Bank economic growth
Reserve Bank Governor Philip Lowe

Contrary to what you might have seen from some media outlets, Australia’s long run of problematically low inflation didn’t end in the December quarter, but the Reserve Bank (RBA) still faces a difficult task in deciding whether to further cut interest rates at its meeting on Tuesday.

Headline inflation over the course of 2018 was 1.8% and that’s exactly where 2019 ended as well, according to this week’s consumer price index (CPI) figures. That’s below the 1.9% RBA forecasted for December — close, but when you’re dealing with persistently weak inflation below target, every decimal point counts.

Trimmed mean inflation, a seasonally adjusted measure of core inflation that strips out more volatile items, came in at 1.6%. This is exactly on forecast for the bank, which relies on the trimmed mean figure as a better guide to what’s happening in the economy. But the trimmed mean number has been at 1.6% in annual terms all year, and it’s still below where it ended 2018.

It was the quarterly headline CPI rate of 0.7% that got some commentators excited about inflation for the first time in a long time. But if it hadn’t been for a government-mandated 8.4% rise in tobacco prices (thanks to quarterly rises in excise) and surges in oil prices, annual headline inflation would have been much closer to the trimmed mean.

There’s also little likelihood of inflation sparking in the current quarter, with continued retail chain closures, falling investment and declining consumer sentiment in the wake of the bushfires and the government’s bungled response. The fires may push up some prices, but they’ve also wreaked havoc on the tourism sector.

The jobs market ended 2019 weaker than it started, wages growth dipped towards the end of the year and the coronavirus crisis in China could choke off the last remaining positive for the economy — the solidly performing trade account driven by demand from China for iron ore and education services.

An investment slump in the United States — so much for those corporate tax cuts, eh? — suggests optimists about global growth might be disappointed.

Given this, the RBA would normally be poised to cut rates. But after three rate cuts last year, the central bank is likely to wait and see what happens in the early months of this year.

So far, the 2019 rate cuts have had no impact in the economy except to re-ignite a housing price boom that seems certain to end poorly. There’s also fiscal policy to consider: the bushfires and a need to placate business with some sort of investment allowance — not to mention a possible new round of community sports spending! — means fiscal policy will be a little less contractionary than it was going to be as forecast in the Mid-Year Economic and Fiscal Outlook. But we’ll have to wait for the budget in May to see how much more stimulatory the budget is going to be.

In its monthly business survey for December, released on Tuesday, the National Australia Bank said that while employment remains OK, the wider economy is in trouble:

“Forward-looking indicators do not imply a material improvement in the near term. Forward orders remain weak and capacity utilisation is just below average. Capex has pulled back over the year, and is now also below average.”

And it was a similar story from the Commonwealth Bank’s so-called “Flash PMI” (purchasing managers’ index) for January. The report said this “fell to 48.6 in January, down from 49.6 in December [which signals] a contraction of business activity for a third month running. The latest reading was the lowest since data collection began in May 2016.

“The ongoing weakness was led by a fifth straight monthly fall in manufacturing output, which represents the longest continual decline in goods production in the survey’s history.”

Both surveys strongly suggest that if the economy as a whole is not in a recession, significant parts either are on the verge, or are in the dumps (retailing and wholesaling, plus manufacturing) and could very well drag the rest of the economy in with them.

Without a crystal ball, the RBA faces a tough decision.

Peter Fray

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