ANZ has some sage advice for traders ahead of Australia's inflation report

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New Zealand’s consumer price inflation (CPI) report was released this week, revealing that both headline and underlying inflationary pressures increased over the September quarter.

Coming just a week before the release of Australia’s CPI report, it naturally begs the question as to whether the same outcome will be seen in Australia.

They are, after all, both small, open economies that are price takers for many internationally traded goods, including fuel. And, as many traders already know, both the Australian and New Zealand dollars often move in the same direction, reflecting shifts in sentiment towards the global economy.

It’s easy to see why some deem New Zealand to be a “Mini Me” of the Australian economy.

However, despite the similarities between the two nations, Jo Masters, senior economist at ANZ, says that investors need to be cautious when extrapolating New Zealand’s inflation data to assess what will likely happen in Australia, pointing out that the correlation is not particularly strong between the two reports.

“In annual terms, the headline CPIs have a strong correlation of 0.70 for the period since 2001. However, this weakens to just 0.53 on a quarterly basis,” she said in a note released today.

Source: ANZ

Masters says the lower quarterly correlation reflects that both New Zealand’s and Australia’s CPI baskets are heavily weighted towards movements in non-tradable prices, or those that are dominated by domestic factors.

“The influence of those factors means that while there are comparable weightings across some key components like food and housing, price movements are not highly correlated,” she says.

Perhaps of more importance, particularly when it comes to the outlook for interest rate settings, Masters says the correlation between the two nations’ underlying inflation is even lower.

“Core inflation has a lower correlation of 0.62 on an annual basis and just 0.35 on a quarterly basis,” she says.

Source: ANZ

That’s important as this figure is highly influential on the outlook for monetary policy settings from the RBA and RBNZ, stripping away volatile price movements during any given quarter.

Given the chequered track record between the two inflation reports, Masters says investors making investment decisions in Australian financial assets based upon movements in New Zealand’s inflation report could end up being disappointed.

“The hypothesis that surprises forecast in the New Zealand CPI are reliable predictors of Australian outcomes proves, upon testing, to be disappointing,” she says.

“While both the New Zealand and Australian CPI surprised on the downside in the Q2 2017, the data surprise has only been in the same direction in three of the last twelve prints.

“Over longer periods, forecast misses tend to be in the same direction a bit less than half the time, adding to our caution about using the New Zealand print to draw conclusions about the forthcoming Australian print.”

Australia’s September quarter CPI report will be released on Wednesday, October 25. Final forecasts from economists will be released by the end of this week.

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