Cost of living is in retreat which is good news and bad news

WHEN the cost of living retreats — as in, deflation — it creates some positives and negatives for the economy. Malcolm Farr explains.

There’s good news: interest rates are likely to fall further.

BIG price reductions have caused inflation to go backwards, which isn’t the good news it might seem.

Inflation fell by 0.2 per cent in the March quarter, a sign of deflation. The year-on-year figure was a slight rise of just 1.3 per cent.

It was the first deflation recorded by the Bureau of Statistics since the 2008 December quarter.

And it means we might have to face having demands for pay increases rejected more vigorously than they have been recently.

And the Government, already hurting for revenue, might have to confront getting even less from tax in the Budget next week.

The surprise inflation figure was a product of a 2.5 per cent fall in transport costs, powered by a 10 per cent fall in petrol prices, and a one per cent drop in the cost of leisure and cultural activities flowing from 2 per cent fall in international travel and accommodation, and a 1.9 per cent drop in domestic holiday costs.

Food and beverage costs were down 0.2 per cent, in part because of an 11.1 per cent fall in fruit prices.

One consequence of deflation is the strong possibility of lower wage increases. Pay movements are usually based on cost of living rises. If the cost of living is in retreat, the leverage for a pay jump is removed.

Wage growth already is stunted — at the lowest rate of growth in 18 years — and this could prolong that.

The Government relies on the $170 billion harvested from income tax. If wages do not grow, the income tax revenue on which it depends will not increase, and the revenue problem expected to be outlined in next week’s Budget will be worsened.

The Reserve Bank meeting next week will consider the effects of deflation and the markets are anticipating further cut in official interest rates.