Inflation: Cost-pushed and demand-pulled

If anything, the National Australia Bank's July business survey added credence to the Reserve Bank of Australia's optimistic take on the outlook for economic activity in the country, but not inflation which it expects "to pick up gradually as the economy strengthens."

NAB's latest business survey shows Australian business conditions continued to improve strongly, up to a reading of 15 in July from 14 in the previous month. This is the highest level since January 2008 (before the GFC), and exactly three times its long-run average of five.

Strong business conditions helped lift confidence among businesses to a reading of 12 in July versus eight in the previous month and double the long-term average of six, with positive readings reported in all industries. The survey showed profitability rose sharply to 18 in July - the best reading since October 2007 - from 14 in the previous month; trading conditions dipped from 21 in June but remains at an elevated reading of 20 in July; while employment remained unchanged at a solid seven reading - confirmed by the acceleration in the annual growth rate of the ANZ job ads series to 12.8% in July from 10.5% in the previous month.


But while these suggest strengthening growth momentum in the Australian economy, going forward inflation indicators are heading the other way.

After rising by 1.1% in the three-months to June (from 0.9% in the previous three-month period ended May), labour costs eased to just 0.6% in July. Similarly the quarterly growth rate in purchase costs and final product prices decelerated to 0.4% (from 0.7%) and 0.2% (from 0.5%) in the three-months to July, respectively. Retail prices fell by 0.1% in the July quarter after rising by 0.3% in June.

Economics 101 taught us that inflation could either be cost-pushed or demand-pulled. The latest NAB survey shows that there's none of that happening - inflation isn't pushed up by rising costs nor pulled higher by increased demand (due to rising employment and economic growth overall).

Cost pushed. The Australian dollar's appreciation has reduced the costs of imported raw materials and, at the same time, cheapened "not made in Australia" products and services, prompting domestic businesses to lower sales prices to compete.

This is because Australian companies aren't being generous when it comes to pay increases - one that's captured in the latest NAB survey which showed a deceleration in labour costs and the Australian Bureau of Statistics' (ABS) wage price index that remained at a record low 1.9% in the year to the March quarter (the ABS will release the June quarter tally next week).

As the RBA recently noted, "as wages are the largest component of business costs, the outlook for wage growth is particularly important for the inflation outlook."

Without a significant lift in wages to push inflation higher, there also wouldn't be sufficient demand to pull consumer prices up. A dynamic not lost on the Australian central bank. In its August 'Statement on Monetary Policy', the RBA stated: "expectations for low real wage growth remain a key downside risk for household spending."

Not only this, whatever household spending is left would likely be spent on cheaper imports, thanks to the Australian dollar's higher exchange rate.

Read more: NABANZAustralian Bureau of StatisticsEconomicsGFCMonetary PolicyNational Australia BankReserve Bank of Australia
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