By TWD Invest

May 6, 2019 | News

What does the recent inflation data really mean?

Recently, the December Quarter 2018 to March Quarter 2019 Inflation (CPI) in Australia came in at 0.0%, which results in the yearly inflation rate moving down to 1.3%, below the Reserve Bank of Australia’s (RBA) 2% inflation target. Clothing and Footwear came in at -1.4%, while Transport was 1.7% lower due to a reduction in fuel costs, while Health costs lifted 1.7%. Australia’s year end CPI is shown below:

Weak inflation in Australia increases the likelihood that the RBA will lower the Cash Rate from the current 1.50%, placing downward valuation pressure on the Australian Dollar, currently 70.25c against the US dollar. The next Reserve Bank Board Meeting and Monetary Policy Decision is scheduled for Tuesday May 7th, at 2.30pm Eastern time. Currently the market is showing an approximate 60% probability of a rate cut at this meeting which is taking place a few weeks before the next Federal Election on 18th May. Australia’s historic Cash Rate is shown below:

Despite the somewhat sensational headlines around the weak December inflation data in Australia, the reality is weaker prices were contributed to by weaker clothing and footwear prices, potentially a result of trade pressures between China and the US and lower Crude oil prices, both of which Australian monetary policy has little control over.

While a rate cut may assist the currently weakening Australian housing market, the reality is that housing prices were pushed too high by interest rates kept at very low levels over the last few years, as well as tax incentives. Encouraging increased debt in the economy by lowering interest rates is probably not currently warranted, especially when the Unemployment rate is sitting at 5%.

Anticipation of a lower Australian dollar increasing Australian company competitive positions on the export market, while increasing margins on commodity products which are mostly sold in US Dollars, combined with potential for lower interest rates reducing debt burdens is helping to support the Australian stock market. The All Ordinaries is shown below:

Inflation data remains weak in many countries due to a combination of factors, including aging populations, weak consumer demand, technology driving down costs and reduced security in the job market. Post the Global Financial Crisis, high consumer and household debt loads now appear to be limiting the rate of increase in demand, maintaining low inflation rates.

One of the primary problems for modern economies is that consumer demand is highly influenced by the availability of credit and willingness of consumers to increase debt loads, this has an obvious end point where debt levels cannot be pushed significantly higher, reducing demand and in some cases, asset prices. A clear example of this can be currently seen in the Australian housing market now reducing in price as household debt to income has increased to just under 200%.

Central banks are generally wary of deflationary pressures in an economy, as deflation can be self-reinforcing. For instance if consumers believe housing prices will be lower in a year, they will tend to delay purchases, reducing demand which will lower prices in a self-reinforcing cycle.

We do not anticipate significant changes to our investments as a result of the weaker inflation data and suggest maintaining exposure to the Australian stock market, while we will likely see continued weakness in the Australian property sector. However, if the RAB does cut rates in May, and we do feel that changes are necessary, we will be in touch.

Words by TWD Invest .