Ahead of today’s interest rates decision by the Reserve Bank, there has been some commentary by economists that a further rate rise is required because service prices continue to rise at a very strong rate.

Economists generally note the increase in service prices because they are much more linked with wage growth than goods. This is because service industries are generally much more labour-intensive than the goods sector.

And while this has been useful in the past for gauging whether or not wages are set to increase at a pace incompatible with the inflaiotn target of 2% to 3%, a close analysis of the CPI data reveals that service price inflation over the past 6 months has slowed drastically and that it has been driven largely by sectors that are either not linked with labour costs or are mostly within the public sector and thus are not reactive to interest rate rises.

Annual services prices grew 6.3% in the year to June, faster than the 6.1% in the year to March and the 5.5% in the year to December 2022.

This would suggest that service prices are increasing at a fast rate, in contrast to the inflation of goods which has slowed over the past 3 quarters

But this greatly misreads the data.

The annual growth of service prices is artificially boosted by a big 2.1% quarterly jump in the December quarter last year.

But half of that quarterly growth was largely driven by the exceptional increase in holiday travel costs. Since then the March and June quarters have shown a strong slowing of services prices from that 2.1% to 1.7% in March and now 0.8% in the June quarter.

Even more important is what are now the biggest drivers of service prices. The growth is not coming from services that are not as highly labour-intensive as for example holiday travel and hospitality can be. A third of the increase in service prices in the March quarter was in tertiary and secondary education. While the biggest drivers in the June quarter of services prices were rents, insurance and other financial services.

These three services alone accounted for 81% of the entire increase in service prices in the June quarter.

None of these three services relies on heavy labour intensity, and neither are they likely to fall due to interest rate rises slowing the economy. Interest rate rises can perversely actually drive rental price growth and the main driver of other financial services were “the rise due to stamp duty and higher real estate agent fees.”

It is clear that the Reserve Bank should not use growing service prices as an excuse to raise interest rates.

Inflation is already falling sharply and further rate rises will only unnecessarily increase risks of a recession and growing unemployment.