Inflation eased in June. Fuel prices drove most of the improvement. Strip them out and the picture the Reserve Bank is watching – underlying inflation, housing costs, the labour market – has not moved.
The Reserve Bank has left the cash rate unchanged, choosing to wait for further evidence on whether the interest rate increases already delivered are bringing inflation under control.
Annual inflation eased from 4.0 per cent in May to 3.8 per cent in June, while prices fell by 0.1 per cent over the month. However, much of the monthly improvement came from falling fuel prices. Trimmed mean inflation remained unchanged at 3.6 per cent, while services inflation was 4.0 per cent and non-tradables inflation remained particularly elevated at 4.9 per cent. This suggests that domestically generated inflation remains persistent.
The labour market has also shown little sign of the deterioration that might have been expected following repeated rate increases. Employment rose by 76,300 people in June and the unemployment rate remained at 4.4 per cent in trend terms. Participation also increased, meaning the unemployment rate has remained stable despite more people entering the workforce.
Housing remains at the centre of Australia’s inflation problem. Housing costs increased by 6.8 per cent over the year, making housing the largest contributor to annual inflation. Part of this reflects the ending of electricity rebates, but the pressure extends well beyond utilities. New dwelling prices rose by 5.8 per cent as builders continued to pass through higher labour and materials costs, while rents increased by 3.6 per cent.
Rental inflation has not yet accelerated nationally, with annual growth remaining at 3.6 per cent in June. However, rents are still rising and the full effect of the Federal Budget changes has yet to flow through. Investor demand has already weakened, but it takes time for lower investor purchasing to reduce rental supply, place upward pressure on advertised rents and then become visible in the broader CPI measure. We expect these effects to become more apparent over coming months.
This highlights the difficult position facing the RBA. Higher interest rates can reduce household spending and borrowing capacity, but they do not build homes, lower construction costs or increase rental supply. Further tightening could also discourage new development and investment, adding to the structural housing shortages contributing to inflation.
The decision to hold reflects the fact that headline inflation has eased and previous rate increases are still working their way through the economy. However, unchanged underlying inflation, elevated domestic inflation and a labour market that has not weakened mean another increase remains possible.
House prices are already coming back as buyers respond to reduced borrowing capacity, higher repayments, the impact of the Federal Budget and uncertainty about the interest rate outlook. Holding the cash rate will not stop the decline for now. Buyers are likely to remain cautious until there is greater confidence that rates have reached their peak and uncertainty about the outlook is resolved.
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