Inflation back below 5pc – but getting to 2-3pc remains a challenge

Pendal’s head of government bond strategies TIM HEXT explains the latest inflation data and what it means for the economic outlook

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ANNUAL inflation fell below 5 per cent in July and looks on track to hit 4 per cent or lower by the end of the year as 2022’s higher numbers drop out.

The monthly Consumer Price Index data has been getting more and more comprehensive since first released in October.

More items have joined the monthly cycle and the Bureau of Statistics is now also publishing underlying measures.

On this front the falls are slower, with CPI excluding volatile items (fruit and veg, fuel and travel) falling from 6.1% to 5.8%. Trimmed mean (cutting off the highest and lowest 15%) fell from 6% to 5.6%.

Looking deeper though, the picture is mixed.

Despite a shift lower in goods inflation, services inflation remains stubborn as this ABS graph shows:

The biggest contribution to falling inflation is housing.

Although rents remain strong, the cost of new dwellings is leveling out. At 22% of the basket, housing is important.

Going the other way is insurance.

Anyone who has received a renewal this year can attest to that. However, it is only 2% of the basket.

The other main point we have made before is the ongoing impact of government subsidies on inflation.

These have largely stopped as we emerge from the pandemic, but they well and truly remain in energy.

Electricity rebates from the states meant the average 19.2% rise in prices on July 1 became only a 6% post-subsidy rise for consumers — which is what the CPI measures.

These rebates vary by states. They will reduce the inflation impact in 2023 but risk pay-back next year if the rebates end in 2024 as planned.

It may not feel like it, but electricity is actually only 2.2% of the CPI basket, so these massive moves aren’t game-changers — though there are second-round impacts.

What’s next

For the RBA though, the picture remains clear.

Inflation is moving to 4%. This reduces any urgency around further rate hikes.

The fixed-rate cliff is also now peaking, so overall rates are still rising independent of the RBA.

However, in 2024 the battle to get inflation back into the 2-3% band will be challenging and rate cuts seem a distance away.

Dr Michele Bullock takes over as RBA governor on September 18.

She will be keen to establish her inflation credentials so any move to a dovish outlook is unlikely.

For now, rates remain range-bound – as do risk markets.

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About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.

Find out more about Pendal’s fixed interest strategies here

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About Pendal Group

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

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