Economic and Financial Market Update: Pandemics & Inflation

Summary:

• Inflation in Australia is not going lower, but it is not heading higher;
• The underlying economic trend is starting to improve
• But it will be impacted by the coronavirus, at least in the short term;
• For the next couple of months the RBA will be happy to keep the cash rate on hold.

The recent news flow highlights the difficulty in predicting the economic and financial market outlook. There was the release of the CPI figure. The timing of the data is well known and economists have tried-and tested models to predict the likely outcome (forecasts for the quarterly CPI are typically pretty good). But at the same time there has been news of the spread of a new strain of flu, an event and outcome that is far more difficult to forecast.

Inflation: Not going lower but not heading higher

First, the CPI numbers. The Q4 data indicated that headline inflation picked up by around half percentage point from the start of 2019. The movement in the RBA measure of underlying inflation has been less impressive, remaining at around 1.5% over 2019. The flat lining of the underlying measure is consistent with an economy growing both below trend and with excess capacity (ie, the unemployment rate is too high).

The rise of inflation over recent times largely reflects the impact of a weaker exchange rate (impacting traded and goods inflation) and higher food prices (a result of the drought and swine flu in China). Going the other way, inflation was held down by the big increase in the supply of housing (resulting in lower rents). Measures of inflation that are mainly impacted by the underlying state of the economy (such as non-tradeable and service inflation) were broadly unchanged over the past year.