According to the latest data from the Australian Bureau of Statistics (ABS), the Consumer Price Index (CPI) rose 0.8 per cent in the June 2023 quarter and 6.0 per cent annually, raising concerns about the impact of interest rate increases on the economy.

Prior to today’s inflation numbers, the ASX’s rates tracker suggested there was n 50-50 chance the Reserve Bank of Australia (RBA)  would raise its interest rate by 25 basis points when its board gathers on 1 August. With Australia’s inflation rate falling more than expected, many economists are now predicting the RBA will pause rates next month.

Speaking to the latest figures, Michelle Marquardt, ABS head of prices statistics, acknowledged the slowing of CPI inflation in the June quarter was good news but suggested the annual rate remains worrisome.

“CPI inflation slowed in the June quarter, with the quarterly rise being the lowest since September 2021. While prices continued to rise for most goods and services, there was some offsetting price falls this quarter, including domestic holiday travel, accommodation, and automotive fuel.”

Inflation and CPI by the numbers

If we take a deep dive into the numbers, the most significant contributors to the rise in the June quarter were rents (+2.5 per cent), international holiday travel and accommodation (+6.2 per cent), other financial services (+2.5 per cent), and new dwellings purchased by owner-occupiers (+1.0 per cent).

The statistics also show the current rental crisis is continuing to worsen. There was little relief in the June numbers for those seeking a place to call home.  Rental prices recorded the most substantial quarterly rise since 1988. Marquardt suggests the surge  reflects the low vacancy rates amid a tight rental market.

Food prices (+1.6 per cent) also continued to increase driven by meals out and takeaway foods (+1.7 per cent), fruit and vegetables (+2.4 per cent), and bread and cereal products (+2.9 per cent). Meanwhile, a potato shortage has been restaurants, cafes and takeaway venues feeling the pinch as fresh and frozen potato products were hit with a price increase. Vegetable prices also rose due to some salad vegetables, like tomatoes and lettuces, coming out of season.

On the other hand, there were price falls in specific sectors during the June quarter, providing some respite to consumers. These included domestic holiday travel and accommodation (-7.2 per cent), which came just in time for school holidays and further falls in electricity (-1.8 per cent), clothing accessories (-2.2 per cent), and fuel (-0.7 per cent).

Interest rates and inflation: Did the RBA get it wrong?

Despite the fall in inflation, the question on everyone’s mind is whether the RBA may have made a mistake in its decision to continue hiking interest rates. Economists and financial traders were previously expecting an interest rate rise in August. However, the lower-than-expected inflation data has cast doubts on this move. With the RBA targeting an inflation rate of 2-3 per cent,  the annualised pace of 3.6 per cent on its preferred trimmed mean measure suggests that inflation remains stubbornly high.

Stephen Smith, a partner at Deloitte Access Economics, believes supply-side factors are the primary cause of the recent inflation surge in Australia. He argues that interest rate increases have been largely ineffective in controlling inflation.

“As Deloitte Access Economics has been warning for the past 12 months – and as the Reserve Bank’s own research shows – excessive inflation in Australia has mostly been caused by supply-side factors, meaning that interest rate increases have mostly been ineffective at bringing inflation under control, Smith explains.

Smith further highlights that the Australian economy is softening, wage growth is not excessive, and medium-term inflation expectations are not rising, indicating that further interest rate increases by the Reserve Bank may not be warranted.

“Higher interest rates will not encourage a faster energy transition, nor unleash a wave of home building. Instead they will make these issues worse.

“A narrow, dogmatic view of the link between unemployment and inflation fails to recognise the key sources of excessive inflation in Australia at present, and therefore misdiagnoses the correct policy response. Australia’s reform task is both significant and urgent. Supply side inflation needs to be tackled by focusing on fiscal policy, investment and innovation to lift productivity; competition policy to improve efficiency and erode market power; and tax policy to boost prosperity,” Smith concludes.

What’s next?

There’s little doubt that Australia’s rising cost of living and inflation have triggered concerns about the effectiveness of the RBA’s approach to interest rate hikes.

With increasing evidence suggesting that supply-side factors may be driving the inflation surge, the time for more targeted measures to address the root causes of inflationary pressures in the Australian economy is needed rather than arbitrary rate rises.

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