Soft consumer spending and persistent inflation is creating a policy conundrum

Soft consumer spending and persistent inflation conundrum

Australian Bureau of Statistics (ABS) figures released on 30 April showed that Australian retail turnover fell 0.4 percent (seasonally adjusted) in March 2024, suggesting that consumers are feeling cost of living pressures brought on by persistent elevated levels of inflation.

Retail turnover has been flat for the 6 months to March 2024 and was up only 0.8 percent compared to the 6 months to March 2023. To put this growth rate in perspective, save for the pandemic period and the introduction of GST in 2000, this is the weakest growth on record, when comparing retail turnover to the same time in the previous year.

Turnover was down in all industries in March except for food retailing, while the largest falls were recorded in clothing, footwear, and personal accessory retailing and department stores. However, it is interesting that some of the decline can be attributed to the reversal of the Taylor Swift-inspired turnover boost to fashion and accessory retailers in February.

A puzzling aspect of the weakness in consumer discretionary spending is that recent inflation data releases reveal inflation above market expectations, with trimmed mean CPI rising one percent in the March quarter, which was higher than market expectations of 0.8 percent. Softer consumer demand is generally accompanied by weaker inflationary pressures.

The inflationary impact of high immigration

Looking behind the inflation data and how it is determined reveals a clue that may explain this apparent anomaly of persistent inflation at a time of weak household expenditure and soft consumer demand. The answer lies in the link between the cost of housing and house rental costs which comprise approximately 22 percent of the CPI, and Australia’s unprecedented level of immigration.

Rents and new dwelling purchases by owner occupiers are the main drivers of the cost of housing within the CPI. Rents have risen 7.8 percent year-on-year and the cost of new dwellings for owner occupiers is up 5 percent, making these factors significant contributors to the higher than anticipated March CPI.

There is an inextricable structural link between immigration and housing affordability. The link is that an influx of skilled and affluent migrants boosts nominal GDP growth through higher aggregate demand, which in turn, contributes to inflation. This is what’s happening in Australia today.

According to the ABS, in the 12 months to 30 September 2023, net overseas migration represented a gain of 548,800 people into Australia. This is significantly more than the 247,600 migrants who entered Australia pre-COVID in 2019 and 100,000 higher than the previous record set in 2009. Given Australia already had an undersupplied housing market, this explains why the rental market and the cost of a new dwelling has risen steeply, in response to a historically low vacancy rate.

This structural demand for housing poses an inflationary challenge which the RBA has just one tool to work with, and that is Monetary Policy, in the form of high interest rates.

On the other hand, the Federal Government has a range of measures at its disposal to help address the inflation problem, including fiscal policy and immigration policy. It should consider stepping in to help drive inflation lower and path the way for lower domestic interest rates.

What’s next for interest rates?

An inflation rate of between 2 and 3 percent is needed for the Reserve Bank of Australia to be able to cut interest rates. Sustained lower interest rates can only occur when inflation remains within the lower band of this target range.

The Federal Government’s immigration policy is affirmative of inflation at a time when the RBA is challenged by persistent inflation that is inhibiting the RBA’s ability to materially effect a sustainable reduction in its Official cash rate. This creates a policy dilemma in that the Federal Government’s immigration policy conflicts with what the RBA is seeking to achieve with the current Monetary Policy that it has set in place.

This suggests that the RBA may remain on hold for the rest of the year. RBA Official cash rate expectations have shifted higher over the past week with the 30-day, 90-day and 180-day bank bill swap reference rates all moving higher in the past month, with the Official rate by the end of the year now priced at 4.40% in forward markets, up from 4.10% a week ago.