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Some favourable signs for inflation in Australian capacity use figures but labour market still very tight

• With this cycle having had particularly pronounced demand and supply shocks and central banks globally trying to achieve a better balance between demand and supply, we examine the aggregate and disaggregated measures of capacity utilisation in the NAB Business Surveys in greater detail in this week’s Australian Markets Weekly.
• Cap use has typically been a useful lead indicator of unemployment and shifts in inflationary pressures and as a result, usually also of interest rates. In this cycle, there have been some additional pressures coming through both raw material availability, labour availability and the manufacturing sector which have added to inflationary pressures.
• The recent data show cap use remains very elevated in Australia but has begun to moderate, with weakening trends for forward orders and manufacturing cap use, suggesting that further moderation in cap use and prices is likely in prospect. The analysis suggests the moderation in goods inflation seen in the Q2 CPI has further to run, which was our prior.
• One aspect of the analysis that was somewhat surprising, was the degree to which cap use had been elevated in previous periods (particularly for some industries), without noticeably higher inflation. Interestingly, this occurred with much lower lack of availability of raw materials and lower manufacturing capacity utilisation. This suggests another aspect of how disturbances to supply chains – including of raw materials – may have contributed to additional price pressures in Australia via a temporary but extended reduction in import competition in recent years.
• By the same token – and along the lines of comments by incoming Governor Bullock that a somewhat higher unemployment rate would likely be consistent with a return of inflation to target – some further easing of labour as a constraint on businesses will likely also be required. That process appears to have only just begun.

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