The bugbear of deflation is threatening to claim new victims Down Under, after having already wreaked havoc across some of Asia’s biggest economies.
The latest inflation data from Australia showed the world’s 12th-largest economy has slipped into deflation for the first time in seven years. Falling clothing, food and gasoline prices pushed the consumer price index down 0.2 percent in the March quarter, taking the annual rate to a lowly 1.3 percent rise, its weakest in 17 years.
Even the so-called “core” annual rate, which removes volatile items such as fuel, dropped to just 1.55 percent, well below the Reserve Bank of Australia’s (RBA’s) target range of 2 to 3 percent and economists’ projections for 2 percent.
Tradable goods rose by only 0.6 percent in the three months to the end of March, with fuel and fruit prices leading the decline. Non-tradable goods increased by only 1.7 percent, the slowest rise since 1999, with utilities prices rising by just 0.5 percent. In contrast, pharmaceuticals and secondary education costs both rose by more than 4 percent.
The latest data is “a game changer” for the central bank, JPMorgan’s Sally Auld told Bloomberg News. “Off this base, the inflation trajectory will stay weak for the remainder of the year.”
Auld said she now expected further interest rate cuts from the RBA, forecasting the current record-low official cash rate of 2 percent to reach 1.5 percent by year-end.
The prediction was echoed by traders, which pushed the local currency more than 2 percent lower Wednesday amid market predictions of a 52 percent chance of a rate cut at the RBA’s May 3 policy meeting.
Previously, the central bank had been expected to keep rates steady on the back of low unemployment and improving business conditions.
“Whereas the RBA was previously thinking that low inflation would allow it to cut interest rates if demand faltered, it is now clear that low inflation itself is the problem,” Capital Economics economist Paul Dales told the Sydney Morning Herald.
Complicating the scenario for the central bank is the government’s release of its annual budget later the same day, followed by an expected official announcement of July 3 elections. While officially independent, the RBA has two monetary policy meetings scheduled before the July poll, potentially threatening to disrupt the Turnbull government’s campaign on its economic credentials.
New Zealand Slows
Across the Tasman, New Zealand has cut its official cash rate five times in less than a year amid low energy prices, flat wages and overcapacity that have pushed it toward outright deflation. Consumer prices rose by just 0.2 percent in the first three months of 2016 after declining by 0.5 percent in the previous quarter, on the back of falling fuel costs.
On April 28, the New Zealand dollar surged by more than 1 percent after its central bank left rates steady at 2.25 percent, although it suggested further cuts could be necessary should inflation remain weak.
In a statement, Reserve Bank of New Zealand (RBNZ) governor Graeme Wheeler said there had been a “material decline in shorter-term expectations” for inflation, with headline inflation staying low due to weak fuel and other import prices.
“We expect inflation to strengthen as the effects of low oil prices drop out and as capacity pressures gradually build…Further policy easing may be required to ensure that future average inflation settles near the middle of the target range,” the governor said.
Economists at both Capital Economics and Commonwealth Bank have forecast further rate cuts by the RBNZ, amid downside risks to the inflation outlook and a high Kiwi dollar.
The threat of region-wide deflation has increased markedly in 2016 amid subpar global growth, low oil prices and sluggish wages growth in advanced economies.
In China, producer prices have continued to decline, dropping by 4.3 percent year on year in March after a 4.9 percent fall in the previous month. While the headline consumer price index rose by 2.3 percent, it remains well below the government’s 3 percent target, with “ongoing deleveraging and rising credit defaults” likely to keep rates low, according to ANZ Research.
Neighboring Japan has long been the poster boy for deflation, and the Bank of Japan’s April 28 decision to keep policy settings unchanged and further postpone its time frame for reaching a 2 percent inflation target suggests it remains well within deflation’s grip.
In March, consumer prices excluding fresh food dropped by 0.3 percent, their biggest fall since April 2013, although inflation rose by 0.7 percent excluding energy and food prices.
The BOJ’s core price measure “will likely stay near zero or fall in the coming months because of downward pressure from declines in energy costs,” Tokai Tokyo Research Center chief economist Hiroaki Muto told Bloomberg News. “It’s very difficult to see the inflation rate reaching the 2 percent price goal by the end of the next fiscal year.”
Soft inflation has also struck South Korea, with its central bank forecasting at its April meeting an annual rate of just 1.2 percent, below its 2 percent target, amid a further slowdown in economic growth.
And in Southeast Asia, the Monetary Authority of Singapore surprised markets by adopting last month a policy of zero appreciation in the exchange rate – a measure not used since the global financial crisis.
Singapore’s inflation rate has fallen for 17 straight months, dropping to negative 1 percent in March following a further steep decline in transport costs, while gross domestic product showed zero expansion on an annualized basis in the first quarter amid softness in China and other export markets.
“The economy remains mired in an extended spell of deflation and steadily lower growth,” BMI Research economist Andrew Wood said.
Higher Oil a Salvation?
Falling energy prices may have helped consumers in major importing nations, but their disinflationary effects could start waning soon, according to the World Bank.
On April 26, the Washington-based lender raised its 2016 forecast for crude oil prices to $41 a barrel from $37 previously in its latest “Commodity Markets Outlook” report, suggesting that “an oversupply in markets is expected to recede.”
From a low of $25 per barrel in mid-January, crude oil prices pushed through $40 in April following production disruptions in Iraq and Nigeria and reduced production of U.S. shale.
“We expect slightly higher prices for energy commodities over the course of the year as markets rebalance after a period of oversupply,” World Bank economist John Baffes said. “Still, energy prices could fall further if OPEC increases production significantly and non-OPEC production does not fall as fast as expected.”
Before policymakers start celebrating, the World Bank still expects all the main commodity indices to fall in 2016 due to “persistently elevated supplies.” Energy prices, including coal, natural gas and oil, are projected to drop by 19 percent in 2016, although non-energy commodities such as agriculture and metals are seen dropping by only around 5 percent.
Should higher oil prices not improve the outlook for inflation, analysts have urged both aggressive monetary policy easing and ambitious structural reforms, particularly important due to the region’s worsening demographics.
Examining Japan’s battle against deflation, International Monetary Fund researchers suggested in a 2014 working paper that “combining fiscal consolidation with structural reforms and aggressive monetary easing to achieve the new inflation target can offset the effects of aging.” The researchers assume such reforms can raise the potential growth rate by 0.5 percentage point by 2018, despite an aging and declining population.
“Provided that inflation expectations converge quickly towards the 2 percent inflation target—through aggressive monetary easing and effective forward guidance—such a policy package has substantial benefits by overcoming the deflationary effects of aging, while supporting growth and fiscal sustainability,” they state.
From an isolated example to a region-wide problem, the deflation disease appears to be spreading rapidly through Asia. While policymakers Down Under and in nations with younger populations still have time on their sides, the clock is ticking in the search for a lasting cure.