Inflation globalises, Australian inflation falls

An increasingly integrated world is delivering increasing uniformity in inflation across geographies. In part this reflects the commodity price cycle (notably oil) but there is evidence domestic inflation pressures are becoming more sensitive to global forces in a more integrated globe.

The combination of weak global inflation and ANZ Research's expectation of domestic economic developments in Australia have underpinned a downward revision to our inflation profile.

"Spare capacity in the global economy – as well as the domestic economy – is increasingly important as a determinant for inflationary pressures."
Joanne Masters, Senior Economist, ANZ

We now see a prolonged period with inflation below the Reserve Bank of Australia's 2 to 3 per cent target band. Additionally, we still expect the RBA to loosen monetary policy in the first half of 2016.

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In its most recent annual report, the Bank for International Settlements found “larger trade flows, and above all the greater contestability of both product and factor input markets, have made domestic inflation developments more dependent on international market conditions."

The bank concluded spare capacity in the global economy – as well as the domestic economy – is increasingly important as a determinant for inflationary pressures.

With the global value chain having further to expand and the world running with a negative output gap, the disinflationary pulse is likely to remain in play.

This helps explain why so many economies are under-shooting their inflation targets, including the US and UK where labour markets are approaching full employment. Indeed, unemployment is just 5 per cent in the US and 5.3 per cent in the UK yet core inflation remains below target.

Low headline inflation in part reflects weak commodity prices (notably oil) but mild underlying inflation is indicative of a more integrated world. Increased global competition is keeping both wage and price pressure contained.

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In late September, ANZ Research argued the RBA would need to ease monetary policy over the first half of 2016 as momentum in the key housing and services exports sectors slowed. We continue to believe this will play out, although recent strength in labour market data makes the timing difficult to pin down.

Recent trends in inflation suggest the RBA has scope to ease monetary policy, to run the economy above trend for a period, and to keep interest rates lower for longer.

The weaker than expected September quarter inflation data pointed to benign price pressure across a broad range of items, both tradable and non-tradable.

Inflation is being contained by soft domestic conditions, intense international competition and also the emergence of a globalised inflation factor.


As a small, open economy, Australia is not immune to this disinflationary force. The emergence of the global value chain has increased connectivity between economies and Australia is very much a part of that as both a supplier (most obviously commodities and services to Asia) and a consumer.

More than half of the world's manufactured imports are themselves inputs and more than 70 per cent of the world's services imports are intermediate services. Trade in intermediate goods and services now accounts for over 60 per cent of global trade.

Our modelling suggests the global inflation pulse accounts for around half the movements in the Australian headline Consumer Price Index (similar to that observed in other advanced economies). As a result, while the global inflation pulse is disinflationary, domestic price pressures will have to run above long-term averages to push inflation higher.

This seems unlikely given intense global competition, anaemic wage pressure, soft domestic demand and a slowing in the property market.

Despite the sharply lower Australian dollar in recent years, inflation in those goods and services that are tradable has remained muted as international competition and soft domestic conditions have limited retailers' pricing power.

Indeed, it appears the traditional 'pass through' from the currency to retail prices has changed.

Tradables inflation excluding volatile items (food, fuel and tobacco) has been flat over the past year. The expansion of the online market place is driving a convergence of prices for tradable goods across countries.

However, it is not just internet sales impacting the Australian landscape: there has been a surge of foreign entrants into Australian retail – particularly the supermarket (Aldi, Costco) and clothing space (Gap, Zara, TopShop, H&M, Forever 21, Uniqlo) – which is adding another layer of downward pressure on margins and prices.

Non-tradable inflation (including housing, most services and regulated items) has been running at a faster rate – up 2.6 per cent year on year - although momentum is slowing. Weak wages growth is containing market services inflation while the expected moderation in the residential construction sector should alleviate price pressures on new dwelling purchase costs.

Joanne Masters is a Senior Economist at ANZ

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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