Weird US factor that could wreak havoc on Australia’s inflation and house prices

It’s something so left-field that, in all likelihood, no Australians even think about it. But the fate of our household budgets may rest on it.

Since the resurgence in global inflation first started rising above central bank targets in 2021, Australians have been able to look around the developed world and say “at least ours isn’t as bad as (insert country here)”.

While this remains the case in terms of contrasting Australia with most nations in Europe, which is hard hit by rising energy prices due to the war in Ukraine and the geopolitical tit for tat that has followed, there are already nations such as Canada producing lower year-on-year inflation figures than Australia.

With annual Australian inflation widely tipped by Treasury, the RBA and some of the major banks to tip the scales at 8 per cent when the next quarterly CPI figures are released in January, it increasingly appears that Australian inflationary pressures will soon exceed those seen in the United States.

As of the latest data for the two respective nations, Australian inflation is now 0.4 per cent below the 7.7 per cent year on year figure recorded in the United States in October.

A weird but highly key factor

In a strange twist of fate, everything from the future direction of US inflation to Australian housing prices may rest on the price of American used cars.

It sounds kind of crazy when you attach such weight to something that would otherwise be a forgotten or relatively minor contributor to the US consumer price index.

Yet here we are.

Amid the impact of supply chain issues, pandemic driven demand and trillions of dollars’ worth of government stimulus targeted at households, demand for used cars in the United States rocketed to such a degree that manufacturers and dealers simply couldn’t keep up.

Between the start of 2020 and the peak of US used car prices in January 2022, used car prices rose by a whopping 54.5 per cent, according to the US Bureau of Labor Statistics.

Unlike in Australia where used cars make up a highly negligible contribution to the consumer price index and headline inflation, in the United States used cars make up 4.14 per cent of headline inflation.

While this doesn’t sound like a lot, at its peak contribution to headline inflation in June 2021, 1.88 per cent of the total 5.4 per cent year on year inflation figure was driven solely by rising used car prices.

But as they say, what goes up must come down.

According to the Manheim used car price index, US used car prices have fallen by 15.4 per cent since their peak in January and are continuing to fall rapidly.

US inflation to fall on used car prices

With used cars set to start dragging on the year-on-year US headline inflation figure starting with November’s figures, the big question is how much used car prices will fall and how this will feed into the US consumer price index.

There are number of different scenarios to explore, each with different degrees of implications for inflation and its knock-on effect.

If we assume that used car prices will fall back to roughly where they were prior to the pandemic in inflation adjusted terms over a 12-month period, US inflation could fall by 1.05 per cent year on year.

US used car prices are having a major impact on their inflation. Picture: Mario Tama/Getty Images/AFP.

If they were to fall to where they were pre-Covid and there was no boost provided by higher inflation and wages, they could subtract 1.33 per cent off headline YoY inflation.

But let’s take it to the extreme, let’s imagine that prices not only revert to their pre-Covid trend, but they also fall as much as they did during the GFC from their pre-Covid base. If that scenario were to occur over a 12-month period, used cars could lop 1.67 per cent off the headline figure.

Based purely on this figure, US inflation could come down to as low as 6.0 per cent over the next 12 months should the extreme worst-case scenario be realised.

Trans-Pacific inflation battle

With US inflation set to face this headwind and others such as lower rental inflation in 2023, it increasingly appears that Australia will take the high inflation crown from its American counterpart.

Meanwhile, Australian inflation has yet to price in anything like the rises in rental prices seen in the reports of private property data providers such as SQM Research or PropTrack, all that is yet to be seen in the Aussie CPI into 2023 and perhaps beyond.

There is also the prediction by Treasury that energy bills could rise by as much as 56 per cent over the remainder of 2022 and into 2023, which will contribute significantly to Australian inflation if it does come to pass.

Despite avoiding the worst of things since this latest bout of global inflationary pressures began, it appears that Australia may have only been lagging behind rather than dodging yet another economic bullet.

Going forward

If US used car prices do collapse as some industry sources are warning, then US inflation may come down significantly, perhaps in time even to the point where the Federal Reserve may consider its hawkish approach to monetary policy.

But for Australia, its domestic inflation landscape lacks the same headwinds as its American counterpart, and still needs to price in a great deal of rental inflation that has been in the pipeline for over a year.

The US Federal Reserve is the global benchmark for interest rates and its chairman Jerome Powell is the driving force behind rate policy around the world and any relaxing of tight policy would have implications for Australia.

Ultimately, we’ll just have to wait and see how this factor and others unfold, as the battle over whether or not the future will be an inflationary one is settled by the data in the months and years that follow.

Tarric Brooker is a freelance journalist and social commentator | @AvidCommentator