The unexpected drop in inflation in May has raised speculation about a potential pause in the Reserve Bank of Australia’s (RBA) aggressive interest rate hikes.
However, it is still premature to conclude that inflation has been effectively controlled.
In May, the Australian Bureau of Statistics (ABS) reported that the monthly consumer price index (CPI) fell from 6.8 percent in April to 5.6 percent in May. This figure was significantly lower than the peak of 8.4 percent in December 2022, surprising both markets and economists.
ABS head of prices statistics, Michelle Marquardt, noted that the 5.6 percent increase in May was the smallest since April of the previous year. While prices for most goods and services continued to rise, many of the increases were smaller compared to previous months.
The decline in CPI was primarily driven by a 6.7 percent decrease in automotive fuel prices due to increased global oil production and a stronger Australian dollar, resulting in cheaper import fuel. Holiday travel and accommodation also contributed to the drop in CPI, with a decrease of 11.3 percent in the year leading up to May.
However, the significant price increases in categories such as housing, food and non-alcoholic beverages, furnishings, household equipment, and services offset the downward movement in prices.
Housing prices specifically rose by 8.4 percent in the 12 months leading up to May, a slight decrease from 8.9 percent in April. Annual rents also increased from 6.1 percent to 6.3 percent in May. Additionally, food and non-alcoholic beverages increased by 7.9 percent, and furnishings, household equipment, and services saw a growth of six percent during the period.
Although the drop in the headline inflation figure may have appeared significant, further examination revealed that the decrease would have been less pronounced if volatile items such as automotive fuel, holiday travel, and fruit and vegetables were not included in the CPI basket. In this case, underlying consumer prices would have dipped to 6.4 percent in May, slightly lower than the 6.5 percent rise recorded in April.
Implications of May’s CPI Drop
Despite the notable decrease in May’s CPI, some economists believe that the RBA would still choose to raise interest rates. Barrenjoey economist Jo Masters pointed to higher-than-expected rent increases and an acceleration in services inflation across several spending categories as factors that would influence the RBA’s decision in July.
ANZ Bank economists share this sentiment, stating that underlying inflation measures are not encouraging. They predict that the RBA will continue to raise the cash rate in July and August. However, they acknowledge the possibility of a pause in July if the monthly CPI data affects the RBA’s decision-making process.
While HSBC Bank economist Paul Bloxham sees the latest CPI data as generally positive for Australia, he cautions that inflation remains high. He emphasizes that the easier part of the disinflation process, related to the pandemic and commodity market disruptions, may be reflecting in the numbers, but the more persistent aspects of inflation have yet to subside.
As a result, Bloxham advises against prematurely declaring victory in the battle against inflation.