Squiz Shortcuts - Underlying inflation

Your Shortcut to underlying inflation

With a federal election due in the first half of next year and interest rates likely to influence the outcome, we’re taking a closer look at the number the Reserve Bank says is a major factor in the decisions it makes when determining the nation’s cash rate. It’s called the trimmed mean and in this Squiz Shortcut we’ll get you across:

• what it is

• why it’s important

• and why the Reserve Bank watches it so closely.

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Squiz the Shortcut

What’s the trimmed mean? Sounds like a nasty diet…
Not quite, but it has meant tightening the purse strings for a lot of people as they struggle with the rising cost of living. The trimmed mean refers to underlying inflation. 

Soz, no clearer…
Ok, let’s start with inflation. One of the major reasons for the high cost of living at the moment is inflation, meaning how much more expensive goods and services have become. 

Can you give me an example?
Sure… So, the price of a movie ticket used to cost $3.30 in 1973 and it’s now $24.50 on average. That’s inflation in a nutshell - things get more expensive over time. The Bureau of Stats measures inflation based on a cross-section of those sorts of goods and services - and it shows that our dollar isn’t worth as much as it was fifty years ago.

How is inflation monitored?
Every month, the Bureau of Stats releases the monthly inflation rate - it’s been around 2-3 per cent for the last few months, down from a high of 8.4 per cent in late 2022. This 2-3% band is the target range that the Reserve Bank of Australia - the body that decides whether to cut or raise interest rates - is aiming for. Reserve Bank Governor Michele Bullock says the Board wants inflation sitting comfortably in that range before it considers dropping interest rates… 

Hang on, if it’s within the target range, why hasn’t the Reserve Bank dropped rates yet?
Because there’s another number they’re also taking into account that measures what’s called the underlying inflation rate. That’s the trimmed mean. 

It’s been a while since high school maths, what does the mean mean?
It’s the average of a set of numbers. It’s called the trimmed mean because it trims all of the really large price changes that might be due to short-term or temporary trends from the data being measured. Examples of this might be the electricity rebates people got from the Albanese government, or something seasonal, like a weather emergency that drives up the price of mangoes.

Makes sense… How does the trimmed mean work?
By cutting off all the fringe outliers from the numbers, the Bureau of Stats is able to get a better idea of the underlying inflation. And that’s what the Reserve Bank considers first when making decisions about interest rates. 

Got it. Can the Reserve Bank control inflation?
To an extent… It uses tools like cutting or raising interest rates to stimulate or cool the jets on the economy. If inflation is high, central banks - like the Reserve Bank - will often raise interest rates to try to bring it under control. By raising interest rates, people have less disposable income and less to spend. That lowers demand, which can lead to prices going down.

How far off the target range are we, taking into account underlying inflation?
At the moment, our inflation rate is around 3.5 per cent, so not quite where the Reserve Bank wants it.

Why do people care so much about inflation and interest rates?
Because they affect how much they pay on a mortgage if they have one, how much groceries are costing, and also because the issue of persistent inflation could affect the upcoming election. 

How so?
Put very simply, if the Reserve Bank cuts interest rates, Labor will be pleased as it’s a signal inflation is under control, whereas it benefits the Coalition if there’s no cut between now and the election because they can campaign on Labor not being able to bring inflation under control. 

When is the next federal election?
It’s due to be held by May, so expect to hear more from each side about their strategies to help fix inflation, boost productivity and bring the cost of living under control before we go to the polls. In the meantime (we know you see what we did there), you’ll be a pro at inflation chat.

Onto our recommendations

Reading: The ABS explainer on inflation - Ok, we’re nerding out here but this is a fascinating look at how the prices of some items have changed significantly over time.

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