1

2 November 2018

AUSTRALIAN ECONOMIC DEVELOPMENTS

Australian inflation (the consumer price index, CPI) slowed to 1.9% p.a. in the September quarter

of 2018 (Q3) from 2.1% p.a. in the June quarter of 2018 (Q2), just below the RBA’s target band

of 2 to 3% over the cycle. Core inflation (a less volatile measure which removes volatile and

seasonal items) slowed to 1.8% p.a. This deceleration reflected modest price rises for housing-

related costs such as utilities, rents, property rates and charges, as well as price falls for out-of-

pocket childcare services expenses, communications and household equipment and services.

With national inflation continuing to track below 2%, this means that Australia’s relatively weak

average wages growth (up 2.1% p.a. on average in the private sector and 2.4% p.a. in the public

sector in Q2) is still enough to generate (very modest) real income growth.

Also released this week, the latest data on producer prices (the ABS’ PPI) confirms that input

costs are, on average, rising more strongly than output prices for producers of Australian goods

and services. Price growth in preliminary (+5.2% p.a.) and intermediate (4.7% p.a.) producer

inputs strongly outpaced price growth in producer outputs (+2.1% p.a.) in Q3 of 2018. This ‘growth

gap’ between price rises for final products versus preliminary and intermediate inputs indicates

that business margins were further compressed in Q3 2018.

In other pricing indicators released this week, Australia’s import prices jumped by 1.9% q/q in Q3

due to rising global oil prices (reflecting global production restrictions and capacity constraints).

The lower Australian dollar has also helped to push up import prices. At the same time however,

export prices rose by 3.7% q/q and 14.0% p.a. in Q3. This was driven by higher prices for gas

exports, in response to strong demand for LNG in northern Asia and because LNG prices are

pegged to the international crude oil price (with a two to four month lag).

Australia’s manufacturing sector continued to expand in October. The Australian Industry Group

Australian Performance of Manufacturing Index (Australian PMI®) fell slightly by 0.7 points to

58.3 points in October, indicating further expansion but at a marginally slower pace than in

September. Results above 50 points indicate expansion with higher results indicating a stronger

expansion. The Performance of Services Index (Australian PSI®) for October will be released on

Monday 5 November while the Performance of Construction Index (Australian PCI®) for October

will be released on Wednesday 7 November.

2

Inflation slows to 1.9% p.a. in Q3 2018

The headline consumer price index (CPI) slowed to 1.9% p.a. in the September quarter of 2018

(Q3), just below the RBA’s target band of 2 to 3% over the cycle. In quarterly growth terms,

headline CPI held steady at +0.4% in Q3 2018.

Core inflation (a less volatile measure than headline CPI which removes volatile and seasonal

items) was slightly slower than headline inflation over the year to Q3 2018. It eased to its slowest

rate since early 2017, at +1.75% p.a. (rounded up to 1.8% p.a.), but up from its lowest point in

2016. Underlying inflation is now at the RBA’s end-of-year (Q4 2018) forecast of 1.75% but

remains below the RBA target band of 2-3% over the cycle (chart 1).

Chart 1: Headline and core inflation and RBA forecasts

Source: ABS CPI, Sep 2018; and RBA Statement on Monetary Policy, Aug 2018

Inflation was relatively weak across the board in Q3, with 63.2% of the items contained within the

ABS’ ‘basket of goods’ showing price rises of less than 2.0% p.a. and 39.1% of items within the

‘basket of goods’ showing outright falls in price (i.e. deflation). Australia’s slowing rate of inflation

(headline CPI) in Q3 2018 reflected modest price rises in housing-related items including utilities,

rents, property rates and charges. Utility prices rose by just 0.8% q/q in Q3, much lower than the

6.8% q/q rise this time last year. The introduction of new childcare subsidy arrangements from

July 2018 also helped to reduce headline inflation in Q3.

3

Over the longer term however, even after these modest price rises or declines in Q3, utilities and

childcare prices have risen significantly faster than other prices this decade. Although out-of-

pocket child care prices fell by 11.6% q/q following the introduction of the Child Care Subsidy in

July 2018 (replacing the Child Care Rebate and the Child Care Benefit), child care prices are still

60% higher than they were at the start of the decade. Before this latest price change, they were

up 81% since the start of 2010, compared to a rise of 19% for all CPI since 2010. Similarly, prices

for electricity and gas have risen by 69% and 63%, respectively since 2010 (chart 2).

Chart 2: Electricity, gas and child care price inflation, 2010 to 2018

Source: ABS CPI, Sep 2018.

Reflecting stronger price increases for imports in Q3, prices for tradable goods and services

(accounting for around 35% of the CPI basket) increased by 0.8% q/q in Q3 and 1.4% over the

year – the strongest annual increase since Q3 2014. Prices for tradable goods and services are

largely determined globally and are affected by movements in the exchange rate and in

commodity prices (agricultural as well as resources). Key among these commodities for

Australian inflation in Q3 was the oil price, which pushed up automotive fuel prices in the quarter

and price rises for international travel. Excluding volatile items, such as tobacco and oil, tradable

prices fell by 2.2% p.a. in Q3, indicating an intense competitive environment for other imports.

Prices for non-tradeable goods and services (accounting for around 65% of the CPI basket)

increased by 0.3% q/q and 2.2% p.a. in Q3. Prices for non-tradeable goods and services are

largely determined locally by labour, rent and other local input costs. They include large

categories of consumer spending such as housing, healthcare and education.

4

Table 1: Key inflation numbers, Q3 2018 Quarterly % change Annual % change

Sep-18 Jun-18 Sep-18 Jun-18

Headline CPI 0.4 0.4 1.9 2.1

CPI excluding volatile items 0.4 0.2 1.2 1.8

trimmed mean 0.4 0.4 1.8 1.8

weighted median 0.3 0.4 1.7 1.7

Core CPI (average of trimmed mean and weighted median) 0.4 0.4 1.8 1.8

Tradables 0.8 0.5 1.4 0.3

Non-tradables 0.3 0.3 2.2 3.0

Goods 0.5 0.5 2.2 2.3

Services 0.3 0.3 1.6 1.8

Sydney 0.6 0.4 2.0 2.1

Melbourne 0.2 0.4 2.2 2.5

Brisbane 0.4 0.4 1.8 1.7

Adelaide 0.3 0.4 1.8 2.7

Perth 0.5 0.2 1.2 1.1

Hobart 0.6 0.4 2.7 2.4

Darwin 0.6 0.4 1.3 1.2

Canberra 0.6 0.4 2.5 2.8

Source: ABS CPI, Sep 2018

The product categories that contributed most to headline inflation in Q3 were recreation and

culture (+1.6% q/q and +1.2% p.a.); alcohol and tobacco (+1.3% and +6.8% p.a.) and housing

(+0.4% q/q and +1.6% p.a.). Recreation and culture price rises included a large price increase for

international holiday travel and accommodation (+4.3% q/q and +1.4% p.a.) due to a combination

of summer peak seasons in Europe and America, higher oil prices and the lower Australian dollar

(see Chart 3).

Chart 3: Contributions to CPI in Q3 2018

Source: ABS CPI Sep 2018

5

Across the capital cities, annual inflation in Q3 2018 was again slowest in Perth (+1.2% p.a.) and

fastest in Hobart (+2.7% p.a.) (table 1). The most significant negative contributor to the CPI across

all eight capital cities was for ‘household equipment and services’ items. This fall was due to child

care price falls following the introduction of the Child Care Subsidy from July 2018, which replaced

the Child Care Benefit and Child Care Rebate. All eight capital cities recorded falls in child care

this quarter ranging from -19.8% in Canberra to -7.4% in Darwin. According to the ABS,

“differences in the movements across the eight capital cities is due to a combination of changes

in gross child care fees and varying impacts of the Child Care Subsidy due to differences in

average household incomes.”

Business margins further compressed in Q3 2018

The latest producer price indexes (PPI) indicate that on average, input prices rose more strongly

than output prices for producers of Australian goods and services in Q3. On average, producer

prices for final goods and services rose by 0.8% q/q and 2.1% p.a. in Q3 2018 but intermediate

prices rose by a much stronger rate of 1.2% q/q and 4.7% p.a. and preliminary prices rose by

1.3% q/q and 5.2% p.a.

Pricing pressures were more evident for imported products than domestic products across the

three stages of production. This ‘growth gap’ between (smaller) price rises for final products and

(larger) price rises for preliminary and intermediate products indicates that business margins were

further compressed in Q3 2018. These pricing trends – and their effects on business margins –

have been evident in Ai Group’s Australian PMI®, PSI® and PCI® in for some time.

For manufacturers, output prices rose faster than input prices over the quarter of Q3 of 2018 but

were slower over the year. Manufacturers’ input costs increased by 0.8% q/q and 7.9% p.a.,

driven by input price rises for agriculture goods (especially grain), crude oil and hydrocarbons.

Drought conditions in New South Wales and Queensland are now having an adverse impact on

input costs with some food and beverage manufacturers in the Australian PMI® reporting

disrupted supply and higher prices of raw agricultural inputs (see chart 4). Input prices also remain

elevated for energy-intensive sectors, reflecting their ongoing problems with high input costs for

gas and electricity. The price of gas is influencing the price of electricity, and oil-linked gas pricing

is sending gas prices up again. Imported material prices for manufacturers were up 14.0% over

the year to Q3, reflecting higher global commodity prices (including oil, since Australia is a net

importer). Domestic material prices were up 5.9% p.a.

Pricing for all manufacturing outputs rose by 0.9% q/q and 6.9% p.a. in Q3 2018, driven by higher

prices received for outputs of petrol, natural gas and lamb products. Output price rises were most

evident in the petroleum and coal product (+36.3% p.a.), primary metal (+14.4% p.a.) and printing

(+13.7% p.a.) sectors. Over the year to Q3 however, input prices rose faster than output prices

in 11 of the 15 manufacturing sectors that the ABS tracks. The only sectors where output prices

rose faster than input prices were in food, printing, basic chemicals and primary metals (Chart 5).

6

Chart 4: Australian PMI® input prices and ABS manufacturing input price

index

Source: ABS PPI, Sep 2018.

Chart 5: Difference between output and input price increases over the year

to September 2018

Source: ABS PPI, Sep 2018.

7

Energy input price indexes confirm that electricity input prices for manufacturers were 15.3%

higher than one year earlier while gas prices were up 13.5% p.a. Gas input prices over the quarter

fell 1.3% q/q in Q3 for manufacturers but were still up 51% since the start of the decade. Electricity

input prices for manufacturers are at a new high; 84% higher than prices paid at the start of the

decade. Most of the increase in input prices has coincided with the rise in gas prices available to

industrial customers, which began to rise in 2016, peaking above $20/GJ in the first half of 2017.

Since that time the gas prices offered have roughly halved from the most extreme levels of 2017,

to around $10/GJ. Although much better than 2017, these price levels are still dramatically higher

than the historic average and present a substantial challenge to more gas intensive businesses.

Chart 6: Manufacturers’ electricity and gas input price indexes,

cumulative change

Note: Producer price indexes rebased to March Quarter 2010 = 100.

Source: ABS PPI, Sep 2018.

Export prices rise faster than import prices in Q3 2018

ABS trade price indexes indicate that both imports prices and export prices increased in Q3 2018.

The depreciation of the Australian dollar against the United States dollar had an upward effect on

import and export prices Q3 2018, when valued in Australian dollars. Over the year, export prices

(14.0% p.a.) have risen slightly faster than import prices (+9.8% p.a.) (see chart 7).

Import prices rose by 1.9% q/q in Q3, driven by higher global oil prices, reflecting tight worldwide

supply due to global production restrictions and capacity constraints. Australia is a net importer

of oil, so the price of oil heavily influences the national import price index.

8

The depreciation of the Australian dollar against the US dollar has also had an upward effect on

prices, including for ‘office machines and automatic data-processing machines’ (+3.3% q/q), and

‘miscellaneous manufactured articles’ (+2.5% q/q). Import prices for the manufacturing sector

rose by 8.2% p.a. in Q3. Rising prices for imported inputs have been been noted in the Australian

PMI® for some time. Many respondents noted in September and October that high prices for

imported components are adding to their input costs.

Export prices rose by 3.7% q/q in Q3, driven by gas (natural and manufactured, +12.9% q/q). This

was in response to strong demand for LNG in northern Asia and supply constraints. Export prices

also increased for cereals and cereal preparations (6.9% q/q), reflecting the impact of dry weather

globally in many wheat and barley growing regions.

Chart 7: Annual increases in export and import prices indexes

Source: ABS International Trade Price Indexes, Sep 2018.

9

This week’s data and events, 29 Oct – 2 Nov 2018

Day Date Data/event Data period Result

Tue 30 Oct ABS Building Approvals Sep (M) Aug (M): Total dwelling units approved +3.3% m/m, -14.1% p.a.

Wed 31 Oct ABS Consumer Price Index Sep (Q) Headline +1.9% p.a. Core +1.8% p.a.

ABS Australian Transport Economic Account

2010-11 to 2015-16

N/A

Thu 1 Nov Australian PMI® Oct (M) 58.3 points

ABS International Trade in Goods and Services

Sep (Q) Imports $34.7bn Exports $36.8bn

ABS International Trade Price Indexes Sep (Q) Imports prices +9.8% p.a. Exports prices +14.0% p.a.

Fri 2 Nov ABS Producer Price Index Sep (Q) Preliminary 5.2% p.a. Intermediate demand +4.7% p.a. Final demand +2.1% p.a.

ABS Retail Trade Sep (M) Sep (M): Nominal turnover $26.9bn

M = monthly. Q = quarterly. H = half-yearly. A = annual. All data are seasonally adjusted unless otherwise noted.

Next week’s data and events, 5 Nov – 9 Nov 2018

Day Date Data/event Data period due for release

Result of previous release

Mon 5 Nov Australian PSI® Oct (M) Sep (M): 52.5 points

ANZ Job Ads Oct (M) Sep (M): -0.8% m/m, +4.7% p.a.

Tue 6 Nov RBA Board Meeting Nov (M) Oct (M): Cash rate 1.50%

Wed 7 Nov Australian PCI® Oct (M) Sep (M): 49.3 points

Selected Living Cost Indexes Sep (Q) Jun (Q): Employee LCI +0.4% q/q, +2.3% p.a.

Thu 8 Nov ABS Education and Work 2018 (A) 2017 (A): 66% of 20 to 64 years of age with non-school qualification

ABS Employment and Earnings, Public Sector

2017-18 (A) 2016-17 (A): 1.96mn public sector employees

Fri 9 Nov RBA Statement on Monetary Policy Nov (Q) Aug (Q): N/A

ABS Housing Finance Sep (M) Aug (M): Total dwelling commitments $30.7bn and -2.1% m/m

M = monthly. Q = quarterly. H = half-yearly. A = annual. B= Biennial. All data are seasonally adjusted unless otherwise noted.

.

10

Australian economy: latest full-year growth rates and government forecasts

RBA SoMP (August 2018) 2016-17

a 2017-18

a 2018-19

f 2019-20

f 2020-21

p 2021-22

p

GDP, % change p.a., year end 1.8 3.4 3.25 3.0

Unemployment rate, %, year end 5.6 5.4 5.25 5.25

Inflation (CPI), % change p.a., year end 1.9 2.1 2.0 2.25

Treasury Budget 2018-19 (May 2018)

GDP, % change p.a., year average 2.1 2.9 3.0 3.0 3.0 3.0

Household consumption, % p.a., year average 2.6 3.0 2.75 3.0

Dwelling investment, % p.a., year average 2.8 -0.4 1.5 0.0

Business investment, % p.a., year average -4.0 8.7 3.0 4.5

Terms of trade, % change p.a., year end 14.4 2.1 -5.25 -2.25

Employment growth, % p.a., year end 1.9 2.7 1.5 1.5 1.25 1.25

Unemployment rate, %, year end 5.6 5.4 5.25 5.25 5.25 5.0

Inflation (CPI), % change p.a., year end 1.9 2.1 2.25 2.5 2.5 2.5

Wages (WPI), % change p.a., year end 1.9 2.1 2.75 3.25 3.5 3.5

a = actual f = forecast p = projection Sources: ABS various data; RBA Statement on Monetary Policy (SoMP), latest quarter; Australian Treasury, Budget 2018-19 (May 2018).

Australian economy: latest indicators Economy FX and commodity prices (Thursday afternoon)

RBA official cash rate, % Oct (M) 1.50 - AUD/USD exchange rate US$0.7205 ▲

Real GDP, % change p.a. Jun (Q) 3.4% ▲ Oil price (WTI light crude, USD/BBL)

US$63.60 ▼

Headline CPI, % change p.a. Sep (Q) 1.9% ▼ Gold price (USD/OZ) US$1,233.11 ▲

Unemployment rate, % trend Sep (M) 5.2% ▼ Copper price (USD/tonne, LME spot)

US$6072.00 ▼

Australian Industry Group monthly performance of industry indices Australian PMI® Oct (M) 58.3 ▼

Australian PSI® Sep (M) 52.5 ▲

Australian PCI® Sep (M) 49.3 ▼ M = monthly. Q = quarterly. All data are seasonally adjusted unless otherwise noted. Arrows represent direction of movement relative to last week for prices, and last observation for growth rates and indices. Sources: ABS various data; Ai Group; Australian Financial Review market prices (as of Fri); London Metals Exchange market prices (as of Fri).

Ai Group Economics and Research Team

Julie Toth Chief Economist (03) 9867 0124 David Richardson Senior Economist (02) 9466 5456 Colleen Dowling Senior Research Analyst (03) 9867 0251 Andrew Bridger Economist (03) 9867 0231 Molly Knox Research Assistant (03) 9867 0108 economics@aigroup.com.au www.aigroup.com.au/policy-and-research/economics/