Inflation the cure for economic doldrums

May 2017

Inflation the cure for economic doldrums

Australia needs a dose of inflation to encourage business spending and wage growth and provide a boost for the economy.

  • Economic growth has been ticking along at 2.4% for the past two years, compared to the long term average of 3.48%. The big brake on the economy is constrained consumer spending and high household indebtedness.
  • Inflation could provide a circuit breaker, as it pumps up corporate profits and provides new avenues for wages growth. But there are no signs of it arriving anytime soon.
  • Although the key measure of inflation, the quarterly Consumer Price Index (CPI), came in at 2.1% for the March quarter, a level not seen since 2014, still it was likely uninspiring for the Reserve Bank of Australia. And that’s because core inflation, which strips out volatile elements like petrol pricing, is only at 1.7%, well below the RBA’s target inflation rate of 2-3%, and indicating it will likely hold the cash rate steady at 1.5% this year.
  • We say "likely" because there are some signs emerging that may have inflationary implications. The foremost is strong employment gains experienced in recent months. And it has been accompanied by an increase in the workforce participation rate.
  • Its good news but tempering our enthusiasm is the stubborn and elevated unemployment rate of 5.9%, which is high enough to constrain wage growth unless employment triggers like business spending improve. And in tandem with low wage growth is timid consumer spending. Figures released in April showed retail spending in February fell 0.1% in seasonally adjusted terms, compared to market consensus of a 0.3% increase.

Inflation could provide a circuit breaker, as it pumps up corporate profits and provides new avenues for wages growth.

  • But Australia's domestic issues are not being reflected in local equity markets, with positive offshore investor sentiment and evidence of earnings growth in global equity markets helping to push the S&P/ASX 200 to 5956.50 on May 1, a level not experienced since March 2015.
  • Broad and synchronised growth in developed markets and emerging markets has also helped to underpin improved sentiment. The question now is will the ASX200 break the psychological 6000 barrier? We think it will, having upgraded our end of year forecast to 6250.
  • The upgrade reflects our positive outlook for company earnings. We expect the resources sector to lead as its coming off a low base, and being helped by firmer commodity prices and disciplined capital management.

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