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The unlucky last mile
In last week’s Brief (Inflation uptick surprises markets), we examined the March quarter release of the Consumer Price Index (CPI). Although the annual rate of CPI inflation continued to fall, the decline was less than the market and commentators (including QIC) were expecting, which led to speculation that the decline in inflation had stalled.
This week, we shed further light on the outlook for the CPI by looking at developments in the upstream costs of production; costs that eventually feed through into the CPI. Upstream cost data is contained in the Australian Bureau of Statistics’ (ABS) Producer Prices Index series (PPI).
Of concern, the PPI data showed that the annual rate of producer price inflation rose from 4.1% in the December quarter to 4.3% in the March quarter. More worryingly, producer price inflation has risen steadily since the middle of last year, with the quarterly growth rate increasing from 0.5% in the June quarter of 2023 (to 0.9% in the March quarter) and the annual growth rate rising from 3.9%.
While imported fuel and goods price inflation is moderating, and easing pressure on the CPI, inflation of non-tradeable items, such as rent, costs of housing construction, education and insurance are showing stubborn resistance to a decline in their rates of price growth. And as we will see, these trends are reflected in, and in part emanating from, inflation in producer prices.
According to the ABS, the main contributors to the March quarter growth in producer prices were property operators, tertiary education and construction costs. Property operators (rental and real estate industries) inflation is not surprising given robust demand for accommodation, while tertiary education costs are being driven higher by increases in operating costs and wages.
The dynamics of construction costs are more interesting. The data divide the sector into three components: residential building, non-residential building and heavy & civil engineering (e.g., transport infrastructure for example). Cost inflation is broad based in each of these three industries with aggregate construction cost inflation rising from 5.1% in September 2023 to 5.9% in the March quarter of this year.
Within the construction sector, it is residential building costs which are directly relevant to the CPI through the new dwelling purchases category. The data shows a mild acceleration in housing output cost inflation, rising from an annual rate of rate of 3.9% in the September 2023 quarter to 4.3% in the March 2024 quarter.
However, the composition of housing costs is uneven. Initially, housing costs were pushed higher by Covid-driven supply chain disruptions that impacted global prices of steel, timber and transport costs. As global supply chains have been repaired and transport costs have fallen, inflation of many material inputs into construction has ameliorated.
Since peaking at an annual rate of 17.2% in June 2022, material input costs inflation for housing construction has fallen steadily to just 1.3% in the March quarter of 2024. However, the fall in material input costs has more recently been offset by, predominately, a rise in unit labour costs caused by a shortage of skilled labour to the sector.
So, where are housing construction costs headed over the remainder of the year? Further pressure from unit labour costs can be expected as unions are able to negotiate higher wage deals within the environment of labour shortages.
But the pipeline for housing that has put pressure on labour demand in the sector, may begin to fade. This week, the ABS released the monthly dwelling approvals data for April that showed approvals (a proxy for the future pipeline of dwellings) continued to fall on a trend basis.
Finally, labour market data indicate that employment growth is also trending lower, which should see the unemployment rate continue to drift higher and take some sting out of wage growth.
Nonetheless, producer price data indicate that the “last mile” of reducing consumer price inflation to the RBA’s target band of 2.5% will be hard fought, due to the sustained pressure on unit labour costs. Our view remains that it will take until the middle of 2025 for inflation to move within the RBA’s target band and that the RBA will not consider their first rate cut until late 2024.