House price inflation low on the RBA’s worry list

Consumer Price Index information released by the Australian Bureau of Statistics this week showed that inflation has continued to rise but growth in housing costs has been subdued, particularly for costs relating to the purchase of housing.

The data for the June 2011 quarter showed that over the year, headline inflation rose by 3.6%. The Reserve Bank’s (RBA) preferred measures of ‘core inflation’, the weighted median and trimmed mean, were both lower at 2.7% over the year but up from a recent low of 2.25% over the March 11 quarter.

The RBA has an inflation target where monetary policy (interest rates) is set with the aim of keeping the annual inflation rate between 2-3% over a medium term average. This inflation target was introduced in 1993. Whether you focus on headline or core figures, it is clear that inflationary pressures are growing which is likely to result in higher interest rates at some point.

Many people state that CPI doesn’t effectively measure the cost increases that households are experiencing. The CPI calculation is based on a collection of 11 groups and within these groups the data is broken down into sub-groups. Each element is weighted to calculate the headline or ‘all groups’ inflation figure.

The reason why many Australian’s feel that CPI inaccurately measures the impact on households is because it is the items that households regularly purchase that have recorded the largest CPI increases over the year: Food (+6.1%), Education (+5.9%) and Alcohol and Tobacco (+5.6%), which are recording the greatest increases at the current time. In particular: food and alcohol and tobacco are items that many households purchase at least once a week.

Despite the increasing rate of inflation, the housing component of the index, which is the largest contributor to inflation based on the allocated weightings, has been recording relatively low levels of growth in recent times. Housing costs rose by 4.6% over the 12 months to June 2011 however, over the past two quarters, the CPI housing component increased by 1.3% and 0.4%. In comparison, the all groups inflation figure during the past two quarters was 1.6% and 0.9%. The 0.4% jump in housing CPI was the lowest quarterly increase since September 2002.

The biggest increases in the housing component of CPI over the past year have been amongst those regular housing costs which are largely outside of consumer control: water and sewerage (+12.8%), electricity (+10.7%), utilities (+9.9%) and property rates and charges (+6.2%). All of these sub categories which represent a large proportion of a household’s quarterly bills have risen dramatically over the past year. In fact over the past 10 years these items have increased at an average annual rate of: 7.2% for water and sewerage, 6.7% for electricity and utilities and 5.5% for property rates and charges.

Over the same period, headline inflation has grown at an average annual rate of 2.9% and housing CPI has risen at an average annual rate of 4.4%.

What is perhaps most interesting is the fact that over the last 12 months house purchase costs have recorded the slowest rate of increase amongst all housing sub groups at just 2.4%. The growth in the cost of house purchases is commensurate with the RP Data-Rismark Home Value Index results for June 2011 which were released this week. In fact, on a seasonally adjusted basis, our data shows that capital city property values have actually fallen by -0.9% over the quarter.

According to the CPI data, rents have increased by 4.5% over the last year which is a faster pace of increase than headline inflation at 3.6% and well above the increase in house purchase costs.

Whether you look at the CPI data for house purchase or the RP Data-Rismark figures it is clear that property values are moving at a rate slower than inflation. As a result, affordability of housing is improving. No doubt, a lot of housing remains relatively unaffordable however, as values grow at a rate below inflation and rents increase at a rate above housing purchase costs, over time properties will become relatively more affordable than they are currently. Albeit this will take some time.

With headline inflation now well outside of the RBA’s target range and “core inflation” heading towards the upper limits of the target range, there will be pressure on the RBA to lift interest rates despite the dour mood of consumers resulting in sluggish housing market conditions, credit and retail figures. It is clear that the economy has many issues at the moment however, for the moment, housing is not one. In fact, the RBA has stated on a number of occasions that while we are benefiting for the best terms of trade in 140 years it is very advantageous that sectors such as housing are not ramping up. This week’s CPI data and the RP Data-Rismark Home Value Index results confirm that housing market activity is most certainly not ramping up.

Tim Lawless is research director at RP Data.