Q2 inflation was just released and the headline number was a 3.8% year-on-year rate. While this is above the RBA’s target range of 2-3% and some temporarily higher inflation is welcome to bring the price level back to where it was expected to be prior to the crisis, it is clear that much of this headline number is a temporary spike due to a “base effect” (the CPI was particularly low in 2020Q2 due to the Covid crisis, including measurement issues for prices of goods and services for which exchange was disrupted by the crisis). To see this base effect, note that the CPI suggests prices are only 3.5% higher than they were two years ago in 2019Q2, which corresponds to an annualised inflation rate of only 1.7% over the last two years.

The key for the RBA is that measures of inflation expectations have increased, including a return back up to the (low end of) its 2-3% target range for the break-even 10-year inflation rate of 2.1% in Q1 and sustained at 2.0% in Q2.

Also, the decline in the unemployment rate to 4.9% in June is particularly welcome news, but the economic fallout from the Delta variant is likely to be negative real GDP growth in Q3 and an increase in the unemployment rate. So the RBA’s forward guidance to keep the policy rate at 0.1% until at least 2024 remains an appropriate setting.