Australia’s consumer price inflation (CPI) report will be released later this week.
Of all Australian economic data releases, few, if any, are as important as this report, carrying the ability to change the outlook for Australian interest rates in an instant.
One only has to look at the March quarter CPI report from 2016 for evidence.
Back then, CPI came in so low that it prompted the Reserve Bank of Australia (RBA) to cut rates not once but twice in 2016, contributing to some large gains across Australia’s stock, bond and housing markets, along with a significant decline in the Australian dollar.
However, even with additional monetary policy stimulus delivered by the RBA, it’s been a struggle to muster any inflationary pressures in the Australian economy ever since, seeing the RBA make several downgrades to its inflation forecasts, including in its most recent Statement of Monetary Policy (SoMP) released in November last year.
Given that backdrop, it’s easy to see why this report remains one of the most important on the Australian economic calendar, even if it has lost a bit of clout under RBA governor Philip Lowe who has placed a greater importance on financial stability risks than his predecessor Glenn Stevens in terms of its implications for Australian interest rates.
The December quarter CPI report will be released on Wednesday, and with markets yet again pricing in a rate hike from the RBA within the next 12 months, it will be influential on markets, especially as it will feature new weightings to the Australian Bureau of Statistics’ (ABS) CPI basket of goods and services, creating even more uncertainty as to how it will influence the result.
Headline CPI is tipped to increase by 0.7% for the quarter, leaving the increase on a year earlier at 2.0%. Previously, headline CPI rose by 0.6% in the September quarter, leaving the change over the year at 1.8%.
Core CPI — combining the trimmed mean and weighted median readings from the ABS and of far more importance in relation to the outlook for interest rate settings — is tipped to lift by 0.5% over the December quarter, leaving the increase on a year earlier at 1.9%.
In the September quarter, core CPI rose by just 0.35% — below the 0.5% increase expected — leaving the annual rate at 1.88%, below the RBA’s 2-3% inflation target once again.
Should core CPI increase 0.5% as the markets expect, and without any revisions to prior data, it will leave the annual core CPI rate above the RBA’s 2017 year-end forecast of 1.75%, and likely bolster the view that the next move in Australian interest rates will be higher rather than lower.
However, as mentioned previously, the CPI report is notorious for delivering surprises than can shift interest rate expectations in an instant.
Given that reality, it’s an opportune time to look at what Australia’s economic community think will happen ahead of the report’s release.
We’ll start with Westpac, one of the few major forecasters who correctly predicted the deceleration in inflationary pressures seen in the September quarter of last year.
Justin Smirk, Westpac Bank
Westpac’s forecast for headline Q4 CPI is 0.8%, lifting the annual pace a little from 1.8% to 2.1%.
Q4 core inflation is forecast to print 0.5%, lifting the annual rate to 2.0%. The trimmed mean is forecast to rise 0.52% while the weighted median forecast is 0.57%. The two quarter annualised pace of core inflation is forecast to decelerate to 1.8% from 1.9% — below the bottom of the RBA’s target band.
Why is the core number again lower than the headline? First, you have to remember that the core measures are seasonally adjusted which smooths out some of the quarterly volatility. Secondly, housing costs, which except for the very volatile utility prices of late, tend to always be in the core. And having such a large weight they tend to be a key driver of core inflation. As such, we are looking for steady rates of core inflation in Q4 and going forward through 2018.
Core inflation is still at the bottom of the RBA target band and the expected moderation in dwelling purchases price inflation through 2018, along with consumer goods still captive to a competitive deflationary cycle, it is hard to see core inflation breaking higher.
As the earlier pass–through of the AUD depreciation has faded the appreciation of the currency has come to the fore. Competition in the retail space remains intense, particularly for groceries and clothing and footwear. The New Zealand Q4 CPI came in well under expectations at 0.1% versus a median of 0.4%.
So despite rising energy prices it appears that the risk to the December quarter CPI forecast lies to the downside.
Tapas Strickland, National Australia Bank
Headline CPI is expected to rise 0.7% to 0.8% in the quarter driven by significant rises in petrol (+8%) and vegetable prices (+9%). Risks are weighed slightly to the downside given the possibility of sharp falls in telecommunication prices from the considerable increases in data capacity in mobile phone and NBN broadband plans.
For Core, our models and bottom-up forecasts produce an expected 0.45% quarterly rise. Importantly, all our models now show core inflation slowly rising, even if currently still slightly below 2%.
If core inflation were to print at 0.4% or 0.5%, this would be the fourth quarter in five where the core measures have printed close to this mark and would be suggestive of core inflation settling just a little below 2%. This is important as it would also suggest disinflationary pressures have eased, and correspondingly we should have greater confidence that inflation should start to rise as the labour market tightens.
The RBA is expecting core inflation to be 0.4% quarter-on-quarter and 1.8% year-on-year so an outcome around 0.4% or 0.5% will be in line with their expectations. If core inflation were to surprise to the downside, this would most likely delay RBA interest rate hikes.
For markets, they are likely to be more sensitive to a below consensus print given markets are already pricing in one full RBA rate hike by November and are 50% priced for another by February 2019. The reaction to the weak New Zealand (NZ) CPI last week maybe instructive here — NZ 2-year bond yields fell 5.1 basis points while the NZD dropped 1.5% immediately following. In contrast, a better than expected CPI outcome would likely only see a small extension in RBA pricing given it is already well priced.
Finally, on the link between NZ and Australian CPI. Before the low NZ CPI result our inclination was to see risks to the headline to the upside, but the low NZ tradeables print has trimmed away that risk.
While we now see slight downside risk from data plans, we do not think the Australian CPI will print sharply to the downside as the NZ CPI did, with much of the NZ weakness driven by an unusual 6.2% quarterly fall in car prices. Such unusual price moves should not impact on the core measures, as they would be trimmed out.
Joanne Masters, ANZ Bank
We expect the Q4 CPI data to show a slight pick-up in headline inflation and a broad stabilisation of core inflationary pressures. Numbers in line with our forecast should support the case for a tightening by the RBA in May.
Our forecast is for a quarterly rise of 0.7% for headline CPI, lifting the annual rate to 2%, from 1.8% in Q3 and the 1% low of Q2 2016. Petrol, tobacco and domestic travel and accommodation added to headline inflation in Q4. There is a higher-than-normal degree of uncertainty around this forecast given the introduction of the updated weights and methodological changes, both of which weigh on inflation.
We expect core inflation to rise by 0.4% for the quarter and 1.8% over the year. This is broadly stable from the previous quarter but a clear acceleration from the 1.5% annual rate in 2016.
Benign inflationary pressures continue to reflect weak wages and the impact of retail competition. With retail competition set to remain intense, the recent stabilisation in wage growth is encouraging although we continue to look for only a very gradual pick-up in wages. There does, however, appear to be some upside risk to housing inflation, given the recent strength in building approvals adding to an already solid pipeline of residential construction activity.
Our forecasts are in line with those published in the RBA’s Statement on Monetary Policy, and consistent with the view that inflation has stabilised and is set to gradually rise over time. An outcome in line with our forecast will, we think, provide sufficient comfort around the inflation outlook to pave the way for a 25 basis point rate hike in May.
An outcome of 0.5% for core inflation would obviously strengthen the case for a May rate hike. A lower-than-expected outcome of 0.3%, would still be broadly consistent with the view that inflation has stabilised, particularly given the downward drag from the re-weight. Nonetheless, an outcome this low would place even more emphasis on the Q4 WPI data on 21 February.
Michael Workman, Commonwealth Bank
Inflation pressures in Australia remain benign, for now. We expect headline inflation to rise by 0.7% in Q4 and 2% over the past year. Price rises are forecast for petrol, alcohol and tobacco, housing, holidays and insurance. Price falls are forecast for food, clothing, household goods and communication.
The underlying rate is forecast to rise by 0.5% over the quarter and unchanged in annual terms at 1.9%. On a six month ended annualised basis that smooths out quarterly volatility, some figuring shows an underlying CPI reading of 0.5% lowers the annualised rate from 1.9% to 1.7%pa, or just below the bottom of the [RBA’s] target band. It would take a Q4 rise of at least 0.7% to drive the annualised underlying inflation rate just above the lower end of the target band.
Higher petrol prices over Q4 explain most of the difference between the expected headline and underlying inflation rates.
The inflation forecasts are at the low end of the RBA’s 2% to 3% target band. They do not support any change in the RBA’s cash rate in the short term, even though some of the activity data, like the jobs market, are delivering exceptional growth. But after mid year, we see modestly higher inflation and wages pressures resulting in an RBA rate rise in Q4.
Sally Auld, JP Morgan
We expect that headline CPI increased by 1% over the quarter, led higher by rising fuel prices and a rebound in vegetable prices. Core inflation should remain fairly contained, although on the basis of our group-level forecasts, not all of the strength in food, fuel and tobacco price increases will be trimmed out.
We expect trimmed mean inflation to tick up to 0.6% on rounding, which would put the annual rate at 2.0%. Looking into 2018, we expect core inflation to remain stuck near the bottom of the RBA’s 2%-3% target band. The CPI re-weighting, which occurs in next week’s report, will also be a drag, but a modest one, which accumulates over four quarters. We expect the cumulative detraction to be a little more than 0.1 percentage points.
Shane Oliver, AMP Capital
December quarter inflation data is likely to be consistent with the RBA remaining on hold for now. Higher prices for petrol and tobacco are expected to push headline CPI inflation up to 0.7% quarter-on-quarter or 2% year-on-year, but underlying inflation is expected to remain subdued and below target at around 0.5% [leaving the annual rate at] 1.9%.
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