High services inflation is a problem for the RBA

Similar to the US experience, core goods inflation has slumped, but services inflation remains high.
Kieran Davies

Coolabah Capital

With our earlier analysis suggesting that strong demand has contributed to high core PCE inflation, our more recent work replicating an ECB approach shows that a simple accounting of the drivers of broad domestic prices – including household services – reveals that strong unit labour costs explain most of the recent high inflation.

While useful, the downside to these analyses is that they rely on the national accounts, which are published with a long lag in Australia. 

Taking a much simpler approach, the following charts split core CPI inflation into goods and services, where the core CPI is a reasonable, albeit more volatile, approximation of trimmed mean inflation, which is the RBA’s preferred measure of inflation. 

Goods inflation captures prices that have been affected by global supply disruptions – such as the price of new homes, motor vehicles, household goods, and computers – while services are more reflective of domestic costs, particularly unit labour costs.

Like the US, goods inflation has peaked and slowed sharply at the start of this year, driven by the resolution of earlier supply-chain disruptions. 

However, services inflation remains high, again similar to the US experience, reflecting higher prices for both housing and non-housing services.

This suggest that the RBA is likely to see a goods-driven improvement in underlying inflation this year, but that high services inflation could prove more persistent.

If this proves correct, high services inflation would prove a significant problem for the RBA, delaying the return of overall inflation to the 2-3% target band, particularly when the RBA is forecasting a relatively slow increase in unemployment in response to past interest rate rises.  

The core CPI approximates the RBA's preferred measure of underlying inflation


High core inflation has reflected strength in both goods and services prices 

Core goods inflation has slumped as supply disruptions are resolved ... 

... which is similar to the US experience  
... which is similar to the US experience  

However, core services inflation remains high ... 

... which is also similar to the US experience

High core services inflation reflects strength in both housing and non-housing services 

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Kieran Davies
Chief Macro Strategist
Coolabah Capital

Based in Sydney, Kieran Davies joined Coolabah Capital in 2020, an asset manager than runs over $7 billion in fixed-income strategies, and is responsible for macroeconomic research and investment strategy, contributing to the investment decisions...

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