Electricity prices: no big deal?

The low inflation environment in Australia continued through to the end of 2012 with the consumer price index rising a paltry 0.2 per cent in the quarter and 2.2 per cent through the year.

As any decent and fair economist would suggest, low inflation is the best way to improve purchasing power for wages earners and also to help those in retirement relying on interest and other income. If the general price level is rising at a moderate or low pace, workers don’t need larger wage rises to maintain or increase living standards and retirees don’t need high interest rates to maintain or build their cash flow relative to price increases.

Yesterday’s inflation news is remarkable in terms of what it means for real wages growth and cost of living issues. The 2.2 per cent annual inflation rate is the tenth lowest inflation reading in the last 50 quarters with prices for a range of goods and services actually falling with large price increases confined to a few high profile areas.

The inflation result also validates the low interest rate environment and depending on the global, market and domestic economic indicators, gives the RBA scope to cut interest rates again. That said, the global economic and market news is so positive at the moment that the RBA is unlikely to cut interest rates even though inflation is dead in the water.

Indeed, stock markets rose further overnight extending the bull market evidence since the middle of 2012. This is another sign of rising global confidence in the economic outlook, a point that is likely to dissuade the RBA from cutting interest rates further.

But back to yesterday’s inflation data.

There is a fantastic smorgasbord of information in the consumer price index database which outlines exactly where the average Australian household spends their money.

The debate over the carbon tax has been furious given there have been sharp increases in electricity prices since carbon has had a price. In the past year, electricity prices have risen 17.7 per cent of which about 10 per cent was due to carbon. This is a big rise. That said, the household expenditure weights used by the Australian Bureau of Statistics show that electricity accounts for just 2.5 per cent of the average household expenditure on the basket of goods and services that make up the CPI.

Electricity is, therefore, a small part of the average household budget.

In terms of some comparisons for where an average household spends its money, purchases of tobacco make up 2.5 per cent of average household consumption, the same as electricity. Spending on meals out and take away foods accounts for 5.5 per cent; alcohol 4.8 per cent; rent 6.9 per cent; petrol 3.5 per cent and holidays and accommodation 4.9 per cent.

These spending patterns show just how insignificant electricity is in the scheme of the average household budget, even though it has been the item whose prices has risen the most over the past year.

Think about it. The average household spends as much on tobacco as electricity and spends more than twice that amount on takeaway food and restaurant meals. It seems that the debate about electricity prices is potent because consumers get a big bill each quarter for their electricity using and a price hike is noticeable, whereas weekly spending on a packet of cigarette, a bottle of wine or some takeaway beef and black bean involves a series of small purchases through the course of a three month period and the actual amount spent is frequent, but relatively small.

This is where there may be some who claim “the numbers are wrong, I don’t smoke”. This is wrong in terms of what the CPI is measuring. Less than 10 per cent of households buy a new car each year, but car prices are a vital component of any measure of inflation. The CPI weights are based on the household expenditure survey and are set according to what an average household spends. While only about one-third of the population pay rent, it has a high weight in the CPI basket, as it should, because the inflation data are representative of the average household.

There were some other little gems from the inflation data base. In the past year, food prices rose just 0.3 per cent with lamb and goat prices actually falling 12.4 per cent and fruit prices were 19.0 per cent lower. At the same time, clothing prices fell a further 1.3 per cent, furniture prices were 1.6 per cent lower; car prices fell 1.2 per cent while audio, visual and computing equipment fell 14.2 per cent.

And despite the hype and what is often hysterical chatter about dwelling rent, it rose a moderate 3.7 per cent over the past year, a little above the overall level of inflation, but this is the same sort of increase as wages over the same time frame. Rents really aren’t a problem – it may just be that people are looking in the wrong (that is expensive) suburbs.

It is often enlightening to look at data and facts when making statements about the economy and issues such as cost of living pressures.

Yesterday’s inflation report should smash the myth that people are doing it tough given it clocked up an eleventh consecutive year where wages growth has exceeded the inflation rate. It should also help put context on the electricity price debate because it simply is not that big a deal.

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