Relief all round at signs rate pause will last

THE nation breathed a huge sigh of relief at 11.31am yesterday. It came from home owners, from the Labor Party, even from the Reserve Bank offices in Sydney.

The unexpectedly low inflation figures for the June quarter meant home owners were spared another $50 a month on their mortgage bills. The government was spared the problem of having to explain another interest rate rise to angry voters. And the Reserve was spared the unpleasant task of lifting rates in the middle of an election campaign.

Underlying inflation is now clearly within its target zone of 2-3 per cent, and has fallen to its lowest level for three years. The question now is whether it will stay there. Discounting has clearly played a big part. Weak demand in the retail economy is not only holding prices down, but actually pushing them down.

Of 90 sub-categories the Bureau of Statistics uses to calculate its index, 33 recorded falling prices in the past 12 months, including audio-visual and computing equipment (down 8.3 per cent), almost all types of clothing, as well as holiday travel, almost half the food groups, household supplies and phone bills.

Then why is headline inflation up 3.1 per cent? It comes overwhelmingly from just seven areas:

The rise in tobacco taxes, which affects only smokers.

Rising electricity charges, as growing demand collides with years of underinvestment.

Soaring house prices.

Rising petrol prices, reflecting global trends.

Higher bank margins, due to lack of competition.

Higher rents, due to too little housing construction where renters want to live.

Higher medical bills.

Those areas cover roughly half of household spending. In the other half, inflation was negligible. And that is the half that relies most on our discretionary spending.

Most market economists yesterday seemed confident that inflation will rebound soon, and force the Reserve's hand on rate rises. But then, they were wrong yesterday.

The reality is that inflation will stay low as long as households' discretionary spending remains constrained. There is no sign of that ending.

The fiscal stimulus that has propped up the economy for 18 months is winding down. Global commodity prices are coming off their peaks, reducing export income ahead. And the Reserve's six rate rises since October have yet to fully impact on consumer demand.

This rate pause could last quite a while.