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Resilient inflation and economic recovery to put the RBA on the sidelines
This week’s release of the October monthly CPI in Australia was significant for statistics boffins, economists and market watchers alike. Until now, Australia was the only G20 country to produce a complete CPI on a quarterly, rather than monthly, basis. For the last three years, the ABS has been producing a monthly CPI indicator, which covered around two-thirds of the basket in any one month. But the ABS has now improved measurement of consumer prices to enable it to produce a complete monthly CPI which covers around 90% of the basket every month. The inaugural monthly CPI was released this week.
The monthly CPI will be more volatile than the quarterly CPI but should provide a more timely read on evolving inflation trends. This is particularly important for the RBA in setting monetary policy and comes hot on the heels of the upside surprise to inflation in the September quarter. With the RBA’s preferred underlying, or trimmed mean, inflation measure lifting to an annual rate of 3% in the September quarter, any further upside to inflation will push it above the top of the target band.
The October CPI showed a further rise in both headline and underlying inflation in the month. After bottoming at 1.9% in June, headline inflation has accelerated sharply to 3.8%, predominantly due to rising electricity, fuel and travel costs. Underlying inflation has also risen though, from 2.8% in June to 3.3% in October. This lift in underlying inflation has been driven by higher costs for new home building and an uptick in some services prices, such as the cost of eating out. The higher prices in these sectors reflect a combination of higher input costs and an element of margin rebuilding as the economy improves. Whether or not these price gains are sustained is critical to the inflation outlook.
Our view is that households aren’t yet in a strong enough position to be able to sustain increased price pressures without pulling back on spending. This provides a natural limit to the upside to inflation, as higher inflation directly weakens the already-modest economic recovery.
Until now, the economic recovery that we have seen has been narrowly based around the consumer as incomes improved. The combination of slower inflation, interest rate cuts and the stage 3 tax cuts in the second half of last year, sparked a recovery in real disposable incomes that allowed households to spend more of their take-home pay packets. But the hangover of the cost-of-living crisis and heightened global trade uncertainty has left households with cautious spending habits, choosing to increase savings and wait for sales periods to increase spending. Indeed, this is what we witnessed in the September quarter, with real household spending slowing to just 0.2% in the absence of major sales events, from 0.9% growth in the June quarter.
Other data this week suggested the economic recovery may now be broadening beyond the consumer, with strong growth of 6.4% in private sector capital expenditure in the September quarter, following a period of no growth over the previous year. This was the largest increase in private capex since the mining boom (outside the pandemic) and was relatively broad based. Equipment, plant and machinery investment grew by a very robust 11.5% in the quarter, with investment in this category by the telecommunications industry almost doubling just this quarter driven by investment in data centres and cloud-based services.
New building investment was more subdued but still strong. Building work done rose by 4% in the quarter and 6.5% in the year to September. There has been a particularly strong lift in residential construction of 8.5% in the last year as the industry works to resolve supply constraints and reduce build times amid stronger demand. Non-residential building has also started to recover, while engineering construction has fallen by 1.2% over the last year as government investment pulled back from elevated levels.
Importantly, capital spending plans in the year ahead have lifted, suggesting the rise in the September quarter may represent the beginning of the long-awaited investment recovery rather than a one-time lift. Investment intentions for FY26 now indicate positive growth momentum rather than flatlining. A recovery in business investment is critical to support the consumer-led cyclical upswing, at a time when public sector spending wanes as governments face budgetary pressures.
Next week brings the quarterly report card on the economy, in the form of the September quarter National Accounts. We expect GDP growth to grow at a similar rate to the 0.6% recorded in the June quarter, as the pullback in consumption and high import-content of some of the investment offsets its boost. But with the economic recovery showing signs of broadening beyond the consumer, and inflation continuing to show resilience, the window for RBA easing has likely closed.