Tue 28 Nov 2006

Inflation 'could drop below 2% in 2007'

Australia's annual headline inflation rate could drop below two per cent in mid-2007, a central bank official says.

Australia's annual headline inflation rate could drop below two per cent in mid-2007 as the recent sharp rises in petrol and banana prices unwind, a central bank official said.

Reserve Bank of Australia (RBA) head of economic analysis, Tony Richards, said the consumer price index (CPI) would likely fall over the next year as recent "shocks" to prices moderate.

"Headline inflation has recently been close to four per cent," Mr Richards said at an Australian Business Economists function in Sydney.

"But it would not be surprising to see a rate with a two in front of the decimal place relatively soon, as falling petrol prices flow through into the CPI data," he said.

"Assuming world oil prices remain around current levels, we cannot rule out the possibility that the headline rate might even have a one in front of the decimal place, by around mid-2007, when falls in banana prices are also included.

Mr Richards said this outlook was "essentially unchanged" from the RBA's November quarter monetary policy statement, which said underlying inflation would continue to run at about three per cent in the near-term.

The latest inflation figures from the Australian Bureau of Statistics (ABS) figures showed that headline CPI rose 0.9 per cent in the three months to the end of September for an annual rate of 3.9 per cent - well above the RBA's medium-term target band of two to three per cent.

However, underlying inflation grew at a slower pace during the period due to the reduced impact of volatile price movements.

The RBA's weighted median measure of underlying inflation, which is based on the centre of the weighted distribution of price changes, rose 0.8 per cent in the September quarter for an annual rate of 3.2 per cent.

Meanwhile, the RBA's trimmed mean measure of underlying inflation, which removes the more extreme price changes from the calculations, rose 0.7 per cent in the September quarter for an annual increase of 2.9 per cent.

Mr Richards said recent research by RBA staff found that the trimmed mean measure of underlying inflation performed better than the headline CPI or exclusion measure, which excludes the impact of items that have had particularly volatile prices in the past, when forecasting various measures of near-term inflation.

"Based on data for four economies, this work suggests that - on average - trimmed means tend to outperform headline and exclusion-based 'core' measures on a range of different criteria," Mr Richards said.

However, he said that while further research may result in methodological improvements to inflation calculations, it would be unlikely to find one measure that always outperformed the others.

"All in all, it is unlikely that any single measure of underlying inflation can be held up as the 'best' measure at all times and in all countries," he said.

"This suggests that central banks and other analysts should look at a range of measures when assessing developments in inflation."