Prices deflate, but hang on, there’s a bounce to come in the current quarter

Headline inflation, measured by the Consumer Price Index (CPI) was recorded at -1.9% in the June quarter, marking a remarkable period, if only because it is so irregular. However, dig a little deeper and we can see that inflation was driven lower by some pandemic related events, that are expected to be short term. So short term in fact that prices growth is expected on a broad basis in the current quarter, if not for every sector.

When we say irregular, we mean what we say. The chart here shows Australia’s headline CPI since 1970. The blue bars show quarterly inflation, and sure, there are some periods of deflation you can spot in there. Mostly they coincide with recessions, unsurprisingly. But in fifty years of data, the June quarter is the historic low-point.

Fig 25

To go straight to the dashboard and take a closer look at the data, click here.

Equally relevant, we can see that the June quarter result pushed annual inflation down steeply (that’s the red line and the right-hand axis), to -0.3%. It has been at that level before – way back in the September Quarter of 1997 – but it has never been lower.

If we listen to the RBA’s Assistant Governor, Luci Ellis, Australia is likely to see a recovery in headline inflation. In a recent speech she said:

“Most of the decline in headline CPI will reverse in the September quarter.”

Critically, Dr Ellis went on to say that the reasons for the recovery would essentially be the reversal of the reasons for the rapid fall in inflation. She described these as ‘temporary factors’ and put it like this:

“This decline is entirely accounted for by two factors: the fall in petrol prices and the decision to make child care (and some preschool) free.”

Supporting that proposition, Ross Gittins wrote in The Age that:

“Deflation occurs when price falls are modest, widespread and continuous, the product of chronically weak consumer demand. Businesses cut their prices as the only way to get people to buy what they’ve produced.”

In her speech, Dr Ellis added that if we use different measures of inflation to get a more rounded picture, the result is close to zero, which seems entirely tolerable right now.

The ABS undertook exactly this task in the June quarter, producing the headline CPI described here, but also producing a trimmed mean of all of the price series that are used to make up the CPI. Their table is recreated below, with the trimmed mean highlighted in red.

A result of 0.1% looks a whole lot better than the negative 1.9% in the headline measure!

Table 1. June quarter 2020 Trimmed Mean and Weighted Median, including and excluding imputed series

	Including imputed series (Option 1)		Excluding imputed series (Option 2)
	Quarter (%)	Annual (%)	Quarter (%)	Annual (%)
CPI	-1.9	-0.3	-1.9	-0.3
Trimmed Mean	-0.1	1.2	0.1	1.5
Weighted Median	0.1	1.3	0.2	1.5

The basis for the ABS’ work, and the referencing of it by Dr Ellis is set out here, again from the ABS. What we can see here is the very serious impact that just two items had on inflation: child care costs fell to ‘nothing’ in the June quarter and no one drove anywhere. Price deflation occurred. To read more of the details, click here.

Chart 1. June quarter Trimmed mean and Weighted median including imputed series (option 1)

Fig 27

Based on these alternative measures, we can observe below that the forecasts for inflation still look pretty ordinary through to mid-2021, but then, they start to recover.

Fig 28

So, soon enough, the underlying drivers of longer-term economic concerns (Yes! Looking beyond the pandemic) will return to the centre of our economic thoughts. When that does occur, Gittins makes the sage point that regardless of who is in Government, the:

“…political ideology approach to macro management can’t cope with the developed economies’ tendency to switch from long periods when supply and inflation are the big problem to long periods when demand and unemployment are the big problem.”

None of that means that the economy – or the prices component of it anyway – will bounce back suddenly and hard. What it does mean is, as Dr Ellis puts it is that “It is uncertain how all these forces will play out.”

Indeed. But also, it means that inflation is likely to cease to be the central concern of the domestic economy. It is more likely to be the demand side factors of jobs, incomes, wages growth, retail sales and household debt that will capture the economic imagination in the future.