Annual underlying consumer price inflation (CPI) in Australia now stands at 2%, a two-year high.
It’s currently rising faster than the RBA is expecting.
Economists don’t think it will be enough to see the RBA lift interest rates in the near-term.
While remaining weak from a historic perspective, it looks like Australian inflationary pressures are slowly starting to build.
According to the ABS, underlying consumer price inflation (CPI) rose by 0.52% in the March quarter, seeing the annual rate lift to a more than two-year high of 1.98%.
That’s hotter than the 1.85% level expected by economists, and also well above the 1.75% pace forecast by the Reserve Bank of Australia (RBA).
The acceleration in underlying CPI, while small in the greater scheme of things, suggests that inflationary pressures are now starting to increase, seeing the annual rate move back to the bottom of the RBA’s target for the first time in two years.
If that trend continues in the next few quarters — something the RBA expects will occur gradually — it could see the bank lift official interest rates sooner than markets and most economists currently expect.
The RBA hasn’t increased the cash rate since late 2010, nearly eight years ago.
Now that they’ve ha time to peruse the March quarter CPI report, it’s time to see what economists have made of the modest acceleration in underlying inflation.
Is it a game-changer for interest rates, or is it still far too early to declare that the war against deflationary pressures has been won?
Let’s find out.
Joanne Masters, ANZ Bank
The Q1 inflation print was in line with our forecasts and provides further evidence that inflation is gradually improving, but remains well below the mid-point of the RBA’s 2–3% policy target band.
There were few surprises in the data. While the core measures were solid, it was a little disappointing to see the ANZ Diffusion Index slip back in the quarter and domestic market services inflation steady in annual terms.
From a policy perspective, the focus on making ‘progress toward the mid-point of the band’ suggests that we need to see inflation trending higher before policy is likely to be adjusted. With retail prices expected to continue to drag, a lift in inflationary pressures likely requires stronger wage growth to push domestic services inflation higher. Given this, we continue to watch for signs of an acceleration in wage growth.
The Q1 inflation data will support the case that monetary policy is set to be on hold for some time to com. We continue to see the cash rate steady at 1.5% until May 2019.
Su-Lin Ong, RBC Capital Markets,
As has been the case for some time now, we note that the details of the latest CPI release continue to highlight price pressures in a number of key areas which are largely non-discretionary with some reflecting government policy and regulated changes. Annual price increases in health (4.2%), education (2.6%), utilities (9.3%), transport (2.9%), and housing (3.3%) continue to rise well above headline inflation.
These ongoing pressures continue to squeeze disposable income, posing an ongoing restraint to household consumption with a moderating housing market in 2018 an added challenge.
For the RBA, today’s data are likely to reinforce their base case that core inflation has troughed and heading back to target. Indeed, the average of today’s core measures rounds to 2% for the first time in over 2 years. More importantly, after appearing to stall slightly in H2 2017, core inflation looks to have firmed slightly with the latest print and looks to be running a little above the RBA’s forecast. We caution that it is ever so modest, other core measures are weaker, and that the wage/unit labour cost dynamics amid persistent labour market slack do not suggest any real upward momentum.
Nevertheless, we may well see an upward revision to the RBA’s underlying inflation forecast for 2018 to 2% from 1.75% at the upcoming SoMP on Friday, 4 May.
Our own forecasts suggest that core inflation largely lingers around 1.9/2.0% for much of this year and does not move comfortably above 2% until H1 2019 so we would caution that any such revision to the RBA’s forecasts would still imply a pretty well behaved inflation outlook. Whether the RBA begins to normalise policy in H1 2019 — which is our base case — will likely depend on a range of factors with labour market developments remaining key in our view.
Shane Oliver, AMP Capital
The inflation data confirms that underlying pricing pressures in the Australian economy are still weak as the economy is still running below potential and competition in numerous industries remains intense.
Interestingly, there remain a wide dispersion in price growth across the various consumer spending components. Inflation in the private sector part of the economy excluding volatile items is running at just 1.1% year-on-year. This is in contrast to inflation in the government-influenced parts of the economy where inflation is much higher with utilities prices up 9.3% over the year, health costs 4.2%, education 2.6% higher and alcohol and tobacco costs up by 7.0%.
The inflation data confirms that the bottom in inflation for this cycle has occurred. But, price growth is only running at or just below the bottom end of the RBA’s 2-3% target band and there are no signs of any near-term significant price pressures in Australia, particularly with subdued wages growth. So the RBA is likely to remain on hold.
Our base case is for a rate hike in the first quarter of next year but ongoing soft growth, low inflation, low wages growth and the tightening in bank lending standards now underway around borrowers’ income and expense levels indicates that the risk is that the RBA will remain on hold for much longer and that another rate cut cannot be ruled out.
Ben Jarman, JP Morgan
There is little in the March report to show any pick-up in inflation momentum. We have expected the accumulated rise in unit labour costs after last year’s surge in employment to offer a little support for core inflation in the near term, particularly in services. But this is unlikely to persist as employment growth moderates, and arguably will be offset by the fact that margin compression in goods appears to have become even more intense.
Still, the RBA’s reaction function has shown much lower sensitivity to inflation in recent years, with financial stability constraints preventing further easing, and delivering a couple of years of core inflation below the bottom of the target band. As long as there is stability at these low levels, the data do not present a problem for RBA officials, in their own view.
Rather, activity indicators — particularly the labour market — will dictate the RBA’s level of comfort with low inflation, and the strategy of a much-delayed return the target.
Stephen Walters, Australian Institute of Company Directors
Today’s inflation data for the March quarter revealed yet another subdued result.
There are a number of factors contributing to this unusually extended period of low inflation. The economy still has pockets of spare capacity, including in the labour market, which helps to explain why wages growth is close to record lows. Outside the spike in energy prices, then, there is little cost-push pressure for firms to raise prices. Also, competition in retailing has intensified, particularly from new and powerful offshore players, meaning compression of domestic retailers’ margins continues.
Finally, Inflation overseas also has been unusually low, so Australia is not importing higher prices from elsewhere. Today’s report showed that tradables inflation — prices influenced by overseas factors and the exchange rate — actually was negative in Q1, both over the quarter and the year. Non-tradables inflation, which reflects only domestic considerations, rose 0.8%, and has increased more than 3% over the last year.
For the Reserve Bank, today’s inflation data essentially mean there is no pressure on officials to lift interest rates any time soon. Governor Lowe indicated in a recent speech that the next move in interest rates is more likely to be up than down, but a prerequisite is that inflation returns to the target range. This is likely to happen later this year as more spare capacity is absorbed but, for now, the RBA almost certainly will extend its current record-long period of inactivity on policy.
Paul Dales, Capital Economics
Even though in the first quarter underlying inflation essentially rose back within the RBA’s 2-3% target range for the first time in two years, we doubt this means that the RBA will raise interest rates this year.
There are two reasons why the RBA may not rip up its no near-term hike manta in the coming months.
First, some of the upward pressure on overall prices in Q1 was probably temporary, while some of the downward pressure may linger. Second, with GDP growth unlikely to accelerate much this year and the slack in the labour market still restraining wage growth, we doubt that underlying inflation will rise much further and it could yet fall back below 2.0%.
As such, the RBA will surely leave interest rates at 1.5% next Tuesday and most probably at all the other meetings this year too. It’s still possible that interest rates won’t rise until late in 2019.
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