Low inflation favours interest rate cut

Despite concerns that Australia is one of the most expensive places in the world to live, at least prices aren't rising at a rate the economy can't handle.

Despite concerns that Australia is one of the most expensive places in the world to live, at least prices aren't rising at a rate the economy can't handle.

Analysts expect inflation figures for the first three months of this year, and released on Wednesday, to remain subdued.

The underlying inflation figure, which the Reserve Bank factors into its monthly cash rate decision, is forecast to be about 0.5 per cent for the March quarter and 2.4 per cent year-on year when the Bureau of Statistics releases its data on Wednesday.

The underlying inflation rate has remained comfortably within the central bank's target band of 2 to 3 per cent over the past few years, leaving the door open for the central bank to cut interest rates from a historically low 3 per cent.

Economists expect the headline inflation to be about 0.7 per cent quarter-on-quarter and 2.8 per cent year-on-year.

A senior Reserve Bank official Luci Ellis said on Tuesday that housing prices are expected to rise slowly over the next few years, in contrast to the boom-like conditions for housing a decade ago,

"We think it is very unlikely to return to its 1970s levels, or to rise rapidly once again," said Dr Ellis, who heads up the RBA's financial stability department.

Even so, inflation risks remain in the form of the two-speed divide between goods divided into "tradables" and "non-tradables".

About 40 per cent of the "basket" of goods and services the Bureau of Statistics uses to measure the consumer price index each quarter consists of tradables - goods that have prices determined on the world markets such as clothing and electronics. These prices have been experiencing some deflation because of the strong Australian dollar.

The other items are non-tradables - goods and services that have to be consumed where they are bought, such as rent, utilities, insurance and education. And these prices have been rising over 3 per cent for most of the past decade.

"When you look at the path of tradables and non-tradables, what you see is the domestically generated prices in services have been growing much more strongly in the past five years than tradables prices," JPMorgan economist Ben Jarman said.

In NSW, residents have had to fork out more as electricity costs soared by more than 60 per cent in some areas over the past three years. At the same time, consumer electronics have experienced some of the largest price falls in the CPI "basket" over a similar period of time, Mr Jarman said.

ANZ senior economist Riki Polygenis said: "The high currency is keeping a lid on a range of retail goods prices. While this may no longer be as great a source of disinflation given the stabilisation of the Australian dollar in 2012, it is contributing to offshore and online competition in the retail space and greater consumer awareness of pricing points."

The continued strength of the dollar has also flowed through to goods and services within the non-tradables sector, pushing firms to search for more efficiency. "Firms started having to make the efficiency adjustments they put off for a long time in order to compete globally because of an elevated currency level, or because they have to compete with imports," Mr Jarman said. "So what you saw in 2012 was one of the best years for productivity for quite a long time."

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