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Financial markets have shifted to price out any chance of a rate hike at the RBA’s June meeting after April CPI showed annual inflation fell to 4.2% from 4.6% in March. That shift comes hot on the heels of last week’s lift in the unemployment rate to 4.5%, which together give the RBA room to pause.
But the fall in headline inflation paints a misleading picture. Much of the decline reflected temporary policy measures, including a halving of the fuel excise and free public transport in some States, while underlying inflation, as captured by the trimmed mean, continued to edge higher to 3.4%.
The detail shows cost pressures picking up again in the insurance sector, including car, home and health insurance. Health insurance premiums rose by 4.4%, on average, the highest in almost a decade. These prices tend to be sticky and will keep inflation elevated. The early signs of fuel cost pass-through continue to build in transport-related items and are spreading through the construction supply chain, with the cost of new home builds up by 0.7% in the month. The cost of postal services has now increased by 10% in the last two months as higher fuel prices lift delivery costs. To date, there has been no clear sign of higher fuel and fertiliser costs feeding into grocery prices.
Looking ahead, price pressures are likely to intensify. The cut to the fuel excise is set to expire at the end of June, leading to higher petrol prices. Higher fuel costs have yet to fully work their way through supply chains, suggesting inflation in construction and groceries, in particular, will rise further from here. Whether or not that eventuates depends critically on developments in the Middle East. A resolution to the conflict in Iran, and the reopening of the Strait of Hormuz, would see oil prices fall and limit the inflationary impact. If not, inflation is likely to lift, raising the prospect of further rate hikes.
For now, however, the RBA can afford to wait. After three consecutive hikes, policy is already restrictive, and there are signs emerging of a softening in demand. In the housing market, national house price growth has slowed and prices are falling in both Sydney and Melbourne. Real household spending growth slowed in the March quarter, and April data suggest a continued moderation into the June quarter. And the lift in the unemployment rate points to a gradual loosening in the labour market, reducing the urgency for further tightening while the Bank assesses how its policy adjustments are playing out.
The next test will come with the March quarter national accounts, due next week, which will provide a more fulsome report card on the strength of the economy. Capital expenditure and construction data offer an early read on that outcome. As with inflation, the headline looks promising but the underlying story is less rosy.
New private capital expenditure rose by 6.5% in the March quarter, driven by an 18% surge in equipment spending, while buildings and structures declined. Construction activity also looked firm at the headline level, up 3.4% in the quarter, but much of the strength reflects a small number of large projects. Outside of this, activity was softer, with residential construction declining and public infrastructure continuing to unwind. The economy is still expanding, but with a narrowing source of momentum.
That narrowing reflects the composition of investment. The strength of capex was overwhelmingly driven by IT-related spending, with investment in data centres lifting sharply. There is little doubt that investment in data centres and AI is an emerging global thematic, but the magnitude and speed of the rollout may be crowding out investment in other areas. Stripping out IT, capex spending was little changed in the March quarter. Heightened uncertainty, including the conflict in the Middle East, is also likely weighing on investment outside of these themes.
This matters for near-term growth. For next week’s GDP data, the payoff from this surge in investment is likely to be limited. While the IT investment numbers are staggering, with equipment capex up nearly 200% in the March quarter and over 400% over the last year, this type of investment is highly import-intensive, meaning that a significant share leaks offshore rather than supporting domestic activity. The physical data centre buildout, which does support domestic activity, is more modest, contributing to a 2.5% lift in non-residential construction.
Piecing the data together, we expect GDP to rise by around 0.5% in the March quarter, which is slower than at the end of last year but still far from recessionary. It is likely to be an outcome welcomed by the RBA and give it little reason to alter its near-term policy stance.
Markets are right to see the RBA on hold in the near term. But the inflation challenge is far from over, with fuel price pass-through still in its early stages. At the same time, the apparent strength in investment masks a narrower and more uneven growth impulse, and we expect the drag on the economy from higher inflation and interest rates to intensify in the middle of the year. Together, these forces leave the outlook for monetary policy, beyond the very near term, finely balanced.
