From inflation to deflation?

In the cold light of day, Reserve Bank fears of inflation have turned out to be 'noflation', but without fast rates action excessive consumer debt and lack of liquidity could be here to stay.

The latest CPI data from the ABS has revealed noflation for the first quarter of 2012. The previous December 2011 quarter also recorded noflation, contrary to Reserve Bank expectations of inflationary pressure from the minerals boom.

Quarterly CPI

It is likely that tomorrow’s meeting will be the point at which the Reserve Bank will have to abandon its expectations of rising interest rates to tame an Inflation Bogey that has turned out to be noflation in practice. In its April minutes, the RBA board finished with:

"…If slower growth in demand could be expected to result in a more moderate inflation outcome, then a case could be made for a further easing of monetary policy. The board would have the opportunity at its next meeting to review the inflation outlook based on comprehensive new data on prices, as well as information on demand and output. Members judged it prudent to evaluate those data before considering a further policy adjustment."

Can an annualised inflation rate of 1.6 per cent make this case? Interestingly enough, it was less than one year ago when commercial news headlines were still talking about a rate rise – for example, in the Fairfax article RBA’s Stevens hints at August interest rate rise:

"The market has been paying more attention to a recent run of mixed domestic data which has shown jobs growth slowing, weakness in housing and credit and a sharp contraction in the economy in the first quarter as flooding hit coal exports.

"Mr Stevens, however, made it very clear that he remains focused on the longer term impact of a huge trade and mining boom that should boost incomes and investment over time."

One could be almost certain that such a decision is off the cards now, especially given the recent decline in government bond yields for the month of April.

Government Bond Yields

There will also be no fiscal stimulus for the month of April, thanks to the recent austerity measures of the Australian government. This leaves monetary policy to take up the slack for a slow down in government deficit funded growth.

Date:Government Securities on Issue (AU$ millions)
Jan-2012221646
Feb-2012229706
Mar-2012236036
Apr-2012228426*

*As at 20 April 2012

It seems Wayne Swan is playing ball with the big rating agencies to protect the nation’s AAA rating.

Noflation clearly indicates that excessive consumer debt and a lack of liquidity in the present market are causing downward pressure on prices. The standout noflationary phenomenon has been the decline in house prices of 4.8 per cent per cent over the year to December 2011, which is straining many households as many homes fall into negative equity. Graph 3.6 from the Reserve Bank's Financial Stability Review for March 2012 shows a noticeable increase in LVRs greater than or equal to 90 per cent.

According to Perth Now, Western Australia is the second highest state in Australia in terms of negative equity, where 8.5 per cent of homes are currently worth less than was paid for them. Having said this, Graph 3.10 in the same RBA review shows home loan arrears appear to have taken a sharp turn from the increasing trend in the 2011 Financial Stability Reviews.

It seems quite transparent that without a stimulus to liquidity via a rate cut next Tuesday, noflation could easily become deflation in months to come. Some mining boom…

David Lawson is the director of Steve Keen's Centre for Economic Stability Incorporated.