Inflation is easing: what impact will this have on Australians?

While inflation is cooling in Australia, what is the impact on the CPI, housing markets and RBA decisions on cash rates and mortgages?

Inflation in Australia has slowed significantly. Recent figures from the Australian Bureau of Statistics (ABS) show that the Consumer Price Index (CPI) recorded a modest 0.6 per cent increase during the December 2023 quarter, marking the slowest growth since March 2021. Over the past year, the CPI rose by 4.1 per cent, indicating a significant slowdown in the inflation rate during the final months of last year, which was halved compared to earlier periods. 

According to Dr Gonzalo Castex, an economist and Senior Lecturer at UNSW Business School, various factors such as clothing, footwear, holiday travel and furnishings have contributed to the decline in the CPI. Conversely, he says that insurance, financial services, gas, electricity, rent, tobacco, bread and cereal “have played a role in the opposite direction”. 

The ABS says housing rental and electricity prices remain significant contributors to overall rising costs, with a 7.1 per cent increase in rental prices and a 10.7 per cent surge in electricity prices from 12 months to November. 

“The current cash rate of 4.35 per cent appears to be contracting aggregate demand, opening the possibility for the Reserve Bank of Australia (RBA) to reduce its rate in upcoming meetings. This could alleviate pressure on households affected by a significant rent increase and mortgage payments,” says Dr Castex. 

Although inflation has slowed, Dr Castex and Professor Gigi Foster in the School of Economics at UNSW Business School, say this figure is still high. Why is inflation slowing, and what does this mean for Australians and market economics more generally?

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UNSW Business School's Dr Gonzalo Castex says the Consumer Price Index (CPI) change can be attributed to several factors, including clothing, footwear, holiday travel, and furnishings. Photo: supplied

Why is inflation declining?  

Dr Castex: The RBA has implemented a contractionary monetary policy since May 2022. The impact of increasing the cash rate takes some time to influence prices as a consequence of a contraction of the aggregate demand. Consequently, we have observed an overall decrease in prices since January 2023. It’s worth noting that while the current inflation rate has decreased, it still remains over the target. The RBA should continue monitoring the evolution of prices, aiming to keep the inflation rate within the target range of 2 to 3 per cent per year. 

Prof. Foster: Some items in the shopping basket the ABS uses to construct the consumer price index have risen less than in prior data releases. However, some items have kept up the pace. So, depending on what a consumer buys, the “easing inflation” report may or may not match their pocketbook’s experience. 

What will happen if inflation continues to decline? 

Dr Castex: If inflation continues its downward trajectory, the RBA will likely respond by lowering the cash rate. However, new geopolitical developments in the Middle East could potentially impact prices, adding an element of uncertainty to this scenario. There are also other economic indicators to consider, like the unemployment rate, for example. 

The cash rate is a crucial tool in the RBA’s monetary policy toolkit, influencing economic borrowing costs. The RBA aims to stimulate economic activity by reducing the cash rate and making borrowing more affordable. 

Prof. Foster: Some analysts are predicting fewer rate hikes in the near future. However, we are still far from reaching RBA’s target cash rate range of 2-3 per cent. There are also signs that the labour market is still very tight – that’s one of the indicators the RBA uses to determine whether it can keep pushing rates up without knocking the economy into a visible downturn. I expect we will see more rate hikes this year. 

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UNSW Business School's Gigi Foster says the main factor contributing to our current inflationary situation is the substantial injection of cash by the Australian government into the economy post-COVID. Photo: supplied.

How will this influence the housing market in Australia? 

Dr Castex: In the housing market context, a lower cash rate often leads to decreased mortgage interest rates – which may attract more home buyers and potentially exert upward pressure on home prices.

However, it’s important to acknowledge that the relationship between interest rates, inflation and the housing market is multifaceted. While a lower cash rate may contribute to increased housing demand, other factors such as economic conditions, employment levels and global events also shape market dynamics. The RBA carefully considers these variables in its decision-making process, aiming to strike a balance that supports overall economic stability. 

Prof. Foster: The steady rise in the price of housing is one of the factors pushing inflation higher in recent years. With the government now bringing in vast numbers of immigrants – especially immigrant students, there is more pressure on the housing component of renting consumers’ baskets than during the COVID era. For people with a mortgage, rising interest rates continue to impact Australians considerably. 

While inflation is slowing, is it considered low? And what is considered low?

Dr Castex: Not yet. The inflation rate has been slowing, but it’s important to note that the current level is still relatively high compared to the RBA’s target range. As of the latest release, the inflation rate is 3.4 per cent. This figure exceeds the RBA’s target range of 2-3 per cent, indicating that inflation remains elevated.

Read more: The RBA explained: what we get wrong about the Reserve Bank

In assessing whether inflation is considered low, it’s crucial to consider the historical context of the past ten years. While the recent decline is notable, the absolute level of 4.1 per cent is still considerably higher than the upper bound of the RBA’s target. Generally, an inflation rate within the 2-3 per cent range is conducive to price stability and economic growth. The RBA monitors these trends closely to ensure that inflation remains within this target band. 

Prof. Foster: Definitely not. The primary reason we are in this inflationary situation is that the Australian government poured cash into the economy after putting it into suspended animation during the COVID era. Supply chains were disrupted, fiscal stimulus was distributed liberally to households and businesses without the economic activity there to soak it up, and the RBA delayed raising rates. Now, we’re feeling the consequences of all those mistakes

How will a low inflation rate impact everyday Australians?

Dr Castex: A high inflation rate reflects an overall price increase and higher economic uncertainty; we’ve been observing this trend since 2020. When the inflation rate is high, it can impact everyday Australians in several ways. If our income is not adequately adjusted to match the rising cost of living, it may result in a decline in real consumption. In practical terms, individuals and households may need help to afford the same quantity of goods and services, such as reducing purchasing power for everyday items like apples and bananas. 

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Prof. Foster: The RBA has a target 2-3 per cent inflation rate for a reason: it’s the level at which the economy hums along without people having to think too hard about rising prices and what they mean for contracts, weekly budgeting or anything else, but still while generally feeling upbeat about the economy, and acting accordingly. We need to see a sustained and steady lowering of the inflation rate before the RBA and Australia, more broadly, can adopt a more reassured stance. 


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