Power surge
03 November 2010
We assess the impact of surging utility bills on inflation, household spending and the policy response.
Rising utility charges have been a key contributor to consumer price inflation in Australia in recent years and this provides an interesting policy dilemma for the Reserve Bank of Australia (RBA). On the one hand, rising inflation adds to the case for monetary policy tightening. But, given that these price rises are the result of rising government charges, rather than a reflection of stronger demand, means that it could be harder to justify raising interest rates in this instance.
Indeed, the mostly non-discretionary use of energy, gas and water, implies that rising prices for these goods provides a contractionary force on discretionary consumer spending - which is potentially more significant than the impact of a one-off increase in interest rates.
Utility bills increased by more than 15 per cent in the year to June 2010, the sharpest annual increase in this component of the consumer price index (CPI) since 1983. Moreover, prices were pushed higher again for the 2010-11 financial year. From 1 July 2010 it is estimated that average utility prices in Australia were increased by around 11per cent. The largest price increases were 10 per cent in NSW, 13 per cent in Vic and Qld and 18 per cent in WA.
Given that this is a cost faced by all households, price increases of this magnitude are likely to have a marked effect on consumer behaviour. To highlight this, compare the impact of this change to a 25bps increase in the standard variable mortgage rate.
In the 12 months to June 2010, the average household utility bill was around $2,700. Ignoring changes in the level of usage, an 11 per cent increase in the price of gas, electricity and water will leave households $300 worse off over the 2010-11 financial year. At the same time, there have also been reports of council rates rising by as much as 10 per cent in some areas of NSW and Victoria, which could add a further $200 to the annual bill.
This compares to a 25bps increase in the standard variable mortgage rate, which would result in a $700 per annum increase in the average mortgage repayment (assuming an average owner occupier mortgage of $280,000). Now, while this is a larger increase in fees, it is only applicable to the approximate 35 per cent of households that actually have a mortgage.
As a result, the aggregate impact on household balance sheets and consumer behaviour from the rise in utility prices will be larger than from a rise in mortgage rates. Moreover, a similar argument could be constructed for other areas of non-discretionary consumer spending, such as rents, health and education, all of which have recorded consistently stronger price increase over recent years.
While the rise in the price of utilities alone is large enough to have an impact on consumer behaviour, it is interesting to note that there has also been a sharp upswing in energy usage in the past few months. To be sure, there is always a seasonal increase in energy usage from the autumn to the winter months. But, given that the most recent winter was one of the coldest in over a decade, it is believed that households had the gas and electricity working overtime.
For example, according to the Energy Supply Association of Australia (ESAA) energy demand in NSW increased by around 20 per cent between April (mid-Autumn) and July (mid-winter). The rise in demand in Victoria was around 15 per cent over this same period. When this increase in usage is coupled with an 11 per cent rise in the price of utilities from 1 July, it suggests that many households could see their electricity bill for the winter quarter rise by as much as 30 per cent QoQ.
What does this mean for the Reserve Bank?
The rise in the price of utilities - as well as other non-discretionary items such as rent, health and education - provides an interesting dilemma for policymakers. That is, does the Reserve Bank raise interest rates because of the upward pressure on inflation, or does the contractionary impact on household spending mean that there is less need to tighten monetary policy?
The difference comes down to whether the rise in prices is the result of 'cost-push' or 'demand-pull' inflation.
If inflation is being driven by a rise in demand, then the policy response is simple - raise rates to slow demand and dampen prices. But, if prices are the result of increased costs, due to temporary supply disruptions or increased government charges, then policymakers may be more inclined to 'look through' the initial inflationary impact and only respond if there is an increase in inflationary expectations further down the track. The latter explanation is a better description of current inflationary pressures. Indeed, there is little evidence of stronger consumer demand driving prices higher. For example, the NAB quarterly business survey showed that price inflation in the retail sector over the year to September was the weakest in the history of the survey (dating back to 1989). At the same time, wages growth remains modest.
This demonstrates that rising costs of living are causing households to be more cautious in regards to discretionary spending, and this is an important point to consider when digesting the inflation data.