The economy this month

Inflation drives interest rates high

Australia’s Consumer Price Index (CPI) rose by 0.9% in the December quarter, bringing the annual rate of inflation to 3.0%. This is a sharp increase from the rate of 1.9% recorded in the year to September and brings the inflation rate to the top of the Reserve Bank’s target 2% to 3% range.

The increase in the inflation rate in the 3 months to December would have been greater if it were not for some significant declines in the price of fruit (down 14%) and vegetables (down 7%). These price falls were associated with an improvement in supply levels. Fruit and vegetable prices tend to be quite volatile and December’s price declines may be reversed in subsequent quarters.

One of the main contributors to the jump in inflation over the December quarter was fuel prices, which rose by 7%. Higher world crude oil prices continue to flow through to increased petrol costs for Australian consumers, with the price of petrol rising by 14% over the past year.

Another significant component of inflation in recent times has been housing rents, which rose by 1.6% over the quarter and 6.4% over the past year. Rents are being forced higher as a result of relatively low levels of new home building, which is creating very tight supply levels. This is particularly the case in Perth, where the mining boom has boosted demand. Rental costs in Perth rose by 3.2% in the December quarter.

The Reserve Bank has attempted to stem inflationary pressures via a further tightening of monetary policy. A rise in interest rates from 6.75% to 7.0% is aimed at reducing spending in the economy and thereby taking some demand pressure off prices.

Consumers keep spending

Despite the doom and gloom of financial markets, Australian consumers have continued to spend at healthy rates, providing an important platform for ongoing economic growth and company profits.

In December, the value of retail sales in Australia rose by a seasonally adjusted 0.5%. This followed a particularly strong November growth of 0.8%. With annual growth in sales now over 8%, the Reserve Bank’s program of interest rate increases is yet to materially impact on spending levels.