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  • The Consumer Price Index rose by less than what was expected
  • Inflation is important as it closely ties to unemployment and central bank policy
  • With inflation remaining low, housing prices will continue to be fueled by low interest rates

As reported on The Property Tribune yesterday, the Consumer Price Index (CPI) rose by less than what was expected.

The consensus of economists was a March quarter rise of 0.9%, but the CPI rose by just 0.6%. And the annual inflation figure (average rate of price rises) rose by 1.1%. The central bank (the RBA) wants it to be between 2% and 3%, so it’s not there yet.

Why we watch inflation

It’s important to note that there are different types of inflation.

  • Monetary inflation‘ refers to an increase in the money supply, which the Reserve Bank of Australia (RBA) is currently undertaking through quantitative easing. Putting aside the economic technicalities, there is an inverse relationship between the money supply and interest rates. So when the money supply is increased, this reduces interest rates.
  • Asset price inflation‘ refers to the rise in the price of assets as opposed to ordinary goods and services, such as stocks, bonds, and real estate. This type of inflation is relevant with regard to house prices.
  • Consumer price inflation‘ (CPI) measures changes in a fixed hypothetical ‘basket’ of goods and services that are typically purchased by ‘average household’ consumers across the eight State and Territory capital cities. This is the type of inflation the RBA is focussed on when considering the health of the overall economy (this also ties into wage inflation, discussed further in this article).

There’s a reason why inflation is being talked about in the media constantly. It’s a very important macroeconomic indicator that ties closely with the unemployment rate, wage growth and determines current central bank policy on interest rates.

Most economists agree a small amount of inflation is good, as it brings forward investment and stimulates growth.

But excessive inflation, as evident throughout history, has the potential to curb growth and destroy entire nations leading to more unemployment. High inflation undermines the value of savings and currencies, increases the cost of living, and reduces productivity and competitiveness.

However, fortunately enough, the latest inflation (CPI change) figures shows that we are far from excessive inflation for now.

What do the latest figures mean for housing prices?

The short answer is that the Reserve Bank of Australia (RBA) will continue its exceptionally easy stance on monetary policy. In other words, the prolonged period of very low interest rates looks set to continue. The property boom will not (yet, at least) cause the RBA to raise them, to put a break on the property market.

The long answer is this:

It is clear that the primary goal of the RBA is to reduce unemployment, increasing wage growth in order to get inflation back to its target level.

The simple relationship is unemployment ↓, wages ↑, consumer price inflation ↑.

RBA Governor, Philip Lowe has said wages growth will need to be 3% to 4% in order for inflation (consumer price inflation more specifically) to be lifted back to 2% to 3%.

With inflation so low, this takes the pressure off the central bank to raise interest rates, which are not expected to be lifted until 2023 or 2024.

What can tame the galloping housing market?

As reported previously, the regulatory focus when it comes to the housing market is lending standards, which both the Australian Prudential Regulation Authority (APRA) and the RBA are watching very closely.

Although it has been argued these interventions are “not necessary right now”, tightening lending standards to ensure things do not deteriorate may be a likely path.

These are called ‘macroprudential policies’, which are tools used to restrict bank lending.

For example, if lending is tightened, this might mean you may only be allowed to borrow triple your current income for a deposit as opposed to six times. Another example could be that you must put down 20% on a house deposit instead of 10%. This limits the pool of people capable of participating in the housing market, cooling it down.

So in short, monetary and asset price inflation continues to rise, while consumer price inflation remains stubbornly low. And while consumer price inflation remains low, the RBA is expected to continue a trajectory of low interest rates.

The RBA has once again rejected the warnings of inflation hawks.

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