The latest inflation figures released on Wednesday by the bureau of statistics revealed that petrol prices have risen faster in the past year than they have for a decade and yet at the same time overall inflation remains historically low. At such a time, the government might be tempted to pursue a short-term policy to reduce petrol prices, but ideas such as that from Liberal MP Craig Kelly to cut the fuel excise should be rejected outright.

The September consumer price index growth figures showed inflation growing at just 1.9% – once again below the RBA’s 2% bottom target.

What the past few years have really shown us is the RBA does not have a 2%-3% target range – it has a 3% ceiling. Since March 2016, the RBA’s underlying inflation measure, the “trimmed mean”, has been below 2%, and yet the bank has not altered the cash rate since August of that year:

And these latest figures will do nothing to see the cash rate change.

Upon the release, the value of the Australian dollar fell marginally as the figures didn’t suggest to anyone that the RBA would be about to increase interest rates to curb inflation. And given the bank’s clear lack of concern about inflation below 2% that means we are a long way from any moves. The market is not pricing in any change in the cash rate out to March of 2020 – at which point it would be 43 months in a row with the same rate.

The biggest driver of inflation came from the tradable sector – those items whose price is mostly determined on the world market. In the past quarter the annual growth of tradable items jumped from 0.3% to 1.4%, while the growth of non-tradable items fell from 3% to 2.2%.

And a big reason for this is petrol prices, which have now risen by 20% over the past year –  the biggest annual growth for a decade.

And as petrol prices are always a hot-button political issue, and because an election is near and the current government is looking down the barrel of a rather sizeable election loss, naturally some of the less competent types among its ranks are screaming for something to be done.

Liberal party backbencher (and it should be said long-time climate change sceptic) Kelly suggested on Tuesday the government should reduce the fuel excise by 25% or about 10 cent a litre.

This would cost the budget around $3.5bn a year and would also cost the Liberal party any economic credibility.

Firstly, it must be acknowledged that petrol prices have been rising fast, but we should also remember that just two years ago they were falling equally so:

So why are they rising so quickly, while two years ago they were doing the reverse? It has nothing to do with the government re-introducing the indexation of the fuel excise (one of the few sensible measures Joe Hockey did in the 2014-15 horror budget, even if he completely stuffed up the selling of it) – it is all about the world oil price and the value of our dollar:

Consider that since January the average crude oil price has risen by 14% from US$66/bbl to US$75/bbl, but in Australian dollars it has risen by 27%.

Why has it gone up by more? Because in that time the value of our currency has fallen from US$0.81 to US$0.71. And with the current low inflation figures it has fallen even more – because ironically one of the things keeping the value of our dollar down is our low overall inflation growth which in turns means the RBA is unlikely to raise interest rates:

When the value of our currency goes down it makes buying things from overseas more expensive. And yet the relationship between the price of oil and out petrol prices still holds – the price is a bit higher than you would expect, but not greatly.

Indeed one way to look at it is that in September 2007 the cost of crude oil in Australian dollars was $85/bbl while the index of automotive fuel in the CPI figures was coincidentally also 85. Now the price of crude oil is $104.35 while the fuel index figure is 105.8:

Yes, the petrol price could have gone down by more than it did, but over time the price of petrol is about where you would expect it to be.

And while petrol prices are currently growing much faster than overall CPI, it is worth noting that over the past decade petrol prices in all capital cities have risen by vastly less than inflation:

So reducing the fuel excise won’t actually do anything to keep prices from rising or falling, all it will do is have them slightly lower than they would have been, but at great cost to the budget – at a time when the Parliamentary Budget Office is sounding an alarm that our tax base is shrinking.

In July the PBO noted that because of better fuel efficient cars coupled with Howard and Costello freezing the indexation in 2001 the amount of fuel excise raised each year has fallen rapidly.

Craig Kelly’s proposal would only further erode the tax base at a time when we need to reduce greenhouse gas emissions in transport, which can be done by taxing fuel. Kelly’s policy would thus undermine the budget bottom line and hurt efforts to combat climate change – so not just dumb, but dumb repeated.

What about breaking up the retail petrol companies as suggested by Barnaby Joyce when he argued the divestiture powers to be put in place for the electricity sector should be extended to the fuel sector?

The problem – apart from again it doing nothing to affect the relationship between the world price and the power pump price – is that while our retail petrol sector is concentrated, the Grattan Institute recently found that it was less so than in the past:

The top five retailers control just over 80% of the market compared to 94% back in 2005.

Little wonder Australian Competition and Consumer Commission chairman Rod Sims told the Financial Review that the issue was not retailers gouging customers but “the bigger problem is overseas oil prices and the exchange rate.”

Right now petrol prices are rising fast, but a knee-jerk reaction to them would be a terrible policy. And while things such as cutting the fuel excise may just seem like cheap politics, the cost to our tax revenue would be rather expensive – and would means further cuts to services down the line.

Extracted from The Guardian