Broad based price pressures makes MPC decision tricky
The increase of 6.5% in the CPIX for July strengthened Dynamic Wealths viewpoint over the past few months that inflation is not an oil and food story. Indeed, the numbers show that 8 of the 17 main price categories are increasing at a rate of 6% and more. (See Figure)
Put differently, excluding food and transport, the weighting of all the categories now increasing at 6% or more, is 32.3%. If food and running costs (in the transport category), which have a weighting of 32.98% in the CPIX basket is included, then 65.2% of the consumer goods and services purchased by consumers on average increased by 6% or more since a year ago. In January this year the comparative number was 51%.
The products and services increasing faster than 6% include food, alcohol, tobacco products, fuel and power, household operation, housing, education and personal care.
The fact that the increase of 6.5% was higher than market expectations is not surprising. Dynamic Wealth for some time predicted that the increases in the PPI, which has increased by more than 11% two months ago, will eventually filter through to the CPIX. Especially food prices will continue to face pressure from the PPI. In addition, municipal and rent increases are putting pressure on the housing component to rise faster.
However, notwithstanding the worse than expected numbers, another rate increase in October is not a certainty. Interest rates are designed to change price expectations in the future. Therefore, the Monetary Policy Committee of the Reserve Bank will aim at 2009 when it meets in October. A rate increase in October will thus do little to prices in the first quarter of next year when CPIX is still expected to be above 6%.
In addition, research by the Reserve Bank says it takes 5 to 8 quarters for interest rates to impact on consumer prices. And 5 quarters has not yet passed since the first increase in rates in June last year. Time is therefore necessary for interest rates to work its way through to consumer prices.
