Description

More accurate forecasts of the Consumer Price Index (CPI)

August 2024

In August 2021 the Reserve Bank of Australia made a very costly forecasting error.  Their forecast for the CPI indicated that price inflation would be at, or slightly below their target band of between 2% and 3% until at least the end of 2023.

The actual CPI data is shown in the chart, along with their forecast.

It was a shocking error because the RBA decided to provide guidance that interest rates would not increase until 2024 at the earliest.  Interest rates were at an emergency low to ward off recession during the Pandemic.

So bad was their forecasting error that rates were hiked too late and rose at the fastest rate in decades, to the great cost of households with a mortgage, especially the recent borrowers who had least equity.

Throughout 2021 consumer price expectations were signaling worsening price inflation in the year ahead – and they were right.  My analysis shows that forecasting CPI based on changes in consumer price expectations is more accurate than market economist and RBA forecasts.

This is attributed to consumers having lower discretionary income on average than economists and so being more observant of and impacted by price changes in the marketplace.

Economists’ expectations tend to be more influenced by trends in past CPI data.

Price inflation has been more “sticky” than the RBA expected and our analysis of individual items in the CPI basket shows why this has been the case and is likely to continue.

Monetary policy may be less effective now and in the future for this reason.

This report will be updated in late September 2024