Statement on Monetary Policy – August 2008 Price and Wage Developments

Recent developments in inflation

The CPI data for the June quarter confirmed that inflation remained high over the first half of 2008. The CPI increased by 1.5 per cent in the quarter, to be 4.5 per cent higher over the year (Table 15, Graph 66). The increase reflected broad-based strength in price pressures, with measures of underlying inflation at around 1.2 per cent in the quarter and between 4¼ and 4½ per cent over the year.

The largest contributor to inflation in the quarter was the deposits & loans component, which rose by 9.5 per cent to be 16.2 per cent higher over the year. The sharp quarterly increase largely reflected a correction in the quarter by the ABS for previous underestimates in this series. The deposits & loans component is mainly driven by the difference between banks' lending and deposit rates, which – based on other data available – appear to have moved broadly together in the quarter. Partially offsetting this upward adjustment, the ABS also included a downward correction to the other financial services component, which had been overestimated during the past year. When financial services and the effect of the change in the child care rebate in 2007 are excluded, CPI inflation was 1.2 per cent in the June quarter and 4.2 per cent over the year. Measures of underlying inflation on this basis were around 1.1 per cent in the quarter and 4 per cent over the year.

Overall, the June quarter data suggest that aggregate inflation may be levelling out, but is yet to show any sign of easing. Price pressures were relatively broad-based in the quarter, which is in contrast to other developed countries, where inflation pressures outside of food and fuel have remained contained (see Box C for further discussion). Around 70 per cent of items in the CPI (by expenditure weight) grew at an annualised rate of more than 2.5 per cent in the June quarter (Graph 67).

Non-tradables inflation remained strong, at 1.0 per cent in the quarter and 5.3 per cent over the year (excluding financial services and the child care rebate changes; Graph 68). The largest contributor to non-tradables inflation over the year was housing costs, in large part due to a 7.7 per cent increase in rents that reflected the current low rental vacancy rates.

Tradables inflation picked up to 1.5 per cent in the quarter, boosted by price changes in volatile items: a 9 per cent rise in petrol prices more than offset a 7 per cent fall in fruit & vegetable prices. Excluding fuel and food prices, tradables inflation picked up to 1.1 per cent in the quarter and 1.0 per cent over the year as prices rose across a wide range of items, especially clothing, furniture, overseas travel and alcohol & tobacco. The strength of the price pressures in some of these components appears somewhat at odds with the continued decline in Australian-dollar import prices.

Costs and margins

Labour cost pressures remain firm, due to the ongoing tight labour market and shortage of suitable labour. However, the different measures of wage costs are subject to significant volatility as well as differences in coverage. The wage price index, which should be free of most forms of compositional change, rose by 0.9 per cent in the March quarter, with year-ended growth firm at 4.1 per cent (Graph 69). The national accounts measure of average earnings, which is conceptually the broadest measure of earnings but very volatile, increased by 4.0 per cent over the year to the March quarter; in trend terms, its pace eased a little to 3.8 per cent. The average annualised increase for new federal enterprise bargaining agreements (EBAs) formalised in the March quarter (adjusted for industry composition) was relatively stable at 3.7 per cent. Private-sector surveys of firms – which provide a broader measure of labour costs – have also shown above-average increases, with a broad upward trend in labour costs in recent years. Overall, based on these data and information from liaison, it appears that recent growth in labour costs has been relatively firm by the standards of the past decade or so, but has not accelerated over the past couple of years.

The relatively steady growth in wages in recent years has, however, been accompanied by slower growth in labour productivity than that seen in the 1990s (Graph 70). In the current decade to date, trend non-farm output per head has grown at an annual rate of 0.9 per cent, compared with 2.2 per cent during the 1990s. This implies that labour costs per unit of output have been growing at around 3–4 per cent in recent years.

The Australian Fair Pay Commission's 2008 wage decision, announced in July, granted a $21.66 per week increase in the Federal minimum and all other adult award wages effective from October. For workers on minimum wages, this is equivalent to a 4.1 per cent increase, which is around the pace of economy-wide wages growth. The implied increase across all award-wage workers – who comprise around one-fifth of employees – is around 3 per cent.

Producer price data suggest that upstream cost pressures also remained firm in the June quarter. At the final stage, prices rose by 1.0 per cent in the quarter to be 4.7 per cent higher over the year. Falling import prices (–1.0 per cent in the quarter and –3.2 per cent over the year) continued to exert restraint on overall final-stage prices (Graph 71). The net effect of volatile items at the final stage was modest in the quarter, with a large rise in petroleum prices partly offset by falls in fruit & vegetable prices.

Upstream cost pressures were broad-based across industries. Manufacturing price inflation picked up further in the quarter and is now growing at around its fastest pace since 1990. Construction prices posted a further solid increase, as increased steel and timber costs were passed on to customers. Prices for property & business and transport & storage services also rose considerably over both the quarter and the year.

Business margins remain strong, although there is some evidence that they are no longer widening. Estimates based on profits data from the ABS suggest that margins in both the broader economy and goods distribution sector – which includes retail and wholesale trade and transport – were at relatively high levels in the March quarter (Graph 72). More recent data from the NAB survey suggest margins may have eased in the June quarter.

Inflation expectations

Inflation expectations are at high levels, and an upward trend is evident across various measures. According to the Melbourne Institute survey of households, the median expectation for CPI inflation over the year ahead was close to 6 per cent in July, compared with 4¼ per cent in April; recent increases may have been partly influenced by the sharp increase in petrol prices that took place up to mid July (Graph 73). Medium-term inflation expectations implied by indexed bond yields are around their highest level in a number of years, although tightness in the supply of indexed bonds could be influencing this outcome. Market economists surveyed by the Bank following the release of the June quarter CPI have continued to increase their near-term inflation expectations. The median expectation for headline inflation over the year to the June quarter 2009 is now 3.3 per cent, up from 3.0 per cent in May (Table 16). Over the year to the June quarter 2010, the median inflation expectation is unchanged at 2.8 per cent. Union officials have left their inflation expectations for the next two years broadly unchanged, while surveys report that the proportion of businesses expecting to increase prices in the near term remains above long-run average levels.