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Analyst report
Inflation reading - just hot air?
November 14, 2007
Brendon Lau, ShareAnalysis
When the recent inflation data hit headlines alongside the impending election, it drew starkly divergent views between economists and the Prime Minister on the future direction of interest rates. If the debate has confused you, we shed some light on why some inflation readings differ from others.
The third-quarter Consumer Price Index (CPI) was up 1.9% on the same period last year. The government has flaunted these low headline figures ahead of the election. However, economists argue that just looking at this headline number for the quarter does not give the full picture.
First, the headline CPI is often subject to temporary price fluctuations that can skew the data. Think cyclone Larry and the price of bananas. More recently, the strong Australian dollar has translated into lower prices for fuel and imports of goods and services. These price fluctuations are likely to be one-offs.
Other factors that influence this CPI reading are changes in government policies on taxes and rebates. While these affect the cost of living, they do not directly reflect the underlying inflationary pressures in the economy. For example, the last quarter's CPI data included a government rebate on childcare costs for the first time, resulting in a 33% decline in costs.
To counteract effects such as those mentioned above, some central banks (like in the US) use exclusion-based 'cores'. This core CPI reading excludes price movements on specific items like oil and food. The Reserve Bank of Australia (RBA) uses the trimmed mean and weighted median measure of inflation instead.
The trimmed mean excludes volatile outlying data that have low chances of reoccurring. These outlying items are not fixed, like those in the core CPI method. By applying an averaging formula on the remaining relevant data, the RBA works out the trimmed mean, or the underlying inflation.
The weighted median is calculated much the same way, except instead of using average prices it uses median prices to calculate the underlying inflation. Median values are the midpoint in a range of numbers that are arranged in order of value.
The RBA believes that the trimmed mean, which is the middle path between headline inflation numbers and core CPI readings, gives a more accurate picture of inflation at the current time when the growth of China and other emerging markets is having two offsetting effects on global inflation, namely, lower prices of manufactured goods but higher raw material and energy costs.
Unfortunately for mortgagees and the federal government, the RBA's trimmed mean came in at 2.9% on the prior year, while the weighted median was up 3.1%. This is on the upper limit of the RBA's target inflation band of 2%-3%, and it looks like an interest rate hike in the near future is almost unavoidable.
Brendon Lau is the editor of ShareAnalysis, a premium retail investment service offered by Aegis Equities Research. Click here for your free trial.
More articles from this edition of CompareShares:
Investing: Going global: investing offshore with global ETFs
Stocks: Stock picks for the long haul - HFA Holdings and Hastie Group
US: Trading the gold stock bull
Rates: Free market curves into danger zone
Markets: Bottom feeding in a panicked US market
Economics: Inflation reading - just hot air?
Smart Investing: ASIC takes action against against Westpoint
Expert Panel (Futures): The SPI as a market predictor
Markets: Mid-week market wrap
Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions. |
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