One of Australia’s best inflation forecasters says price pressures are about to weaken

  • Australian inflationary pressures remain weak, and are showing few signs of strengthening.
  • Westpac Bank has an excellent track record for forecasting inflationary trends in Australia.
  • It says inflationary pressures likely peaked in the June quarter, and will weaken over the next 18 months.

When it comes to forecasting inflation numbers in Australia, few are as good as Westpac’s economics team.

They have an excellent track record, including nailing the undershoot in Australia’s headline consumer price inflation (CPI) print in the June quarter.

As such, we tend to pay attention to what it has to say about the outlook for inflationary pressures, a key ingredient when it comes to official interest rate settings from the Reserve Bank of Australia (RBA).

While most forecasters, including the RBA, think inflationary pressures will gradually increase in the period ahead, Westpac has a different view.

It thinks the top is in.

“We now think we have seen the peak for inflation in 2018 and expect inflation to remain under 2.0% all the way out to end 2019,” says Justin Smirk, Senior Economist at Westpac.

“In the recent past we have stressed that the run of soft updates point to the Australian economy being in a low inflation trap and thus the risks to our forecasts lie to the downside.

“We now think that with the downward revised forecasts the risks to our new profile is more symmetric.”

Smirk says the June quarter CPI report confirmed the competitive margin squeeze in Australia remains firmly in place, and provided little indication that the Australian economy is about to break out of its low inflation trap.

“So far in 2018 we struggle to find any broad inflationary pressure in the Australian economy,” Smirk says.

“Core inflation is just at the bottom of the RBA’s target band — held there particularly by housing, health and education — and we can find little to suggest a risk of a dangerous acceleration. But nor can we find signs that the disinflationary pulse is widening suggesting we could see a significant dip in the rate of core inflation.”

Stuck at low levels, essentially, it helps to explain why markets and Westpac doesn’t see the RBA lifting official interest rates until 2020 at the earliest.

In forecasts released three months ago, the RBA saw headline CPI lifting to an annual rate of 2.25% by the end of 2018, up from 2.1% at present. It forecast it would then remain at that level throughout 2019.

For underlying CPI, of more importance to the outlook for cash rate settings, it forecast that it would sit at an annual rate of 2% until the end of 2019 before lifting to 2.25% by the middle of 2020.

The RBA has previously stated that sustained wage growth of around 3.5% per annum, and an improvement in productivity growth, would likely be required to hold underlying inflation steady at the midpoint of its 2-3% target.

Wage growth, as measured by the ABS Wage Price Index (WPI), grew by 2.07% in the 12 months to March.

Few expect wage growth to lift back above 3% anytime soon given still-elevated levels of underutilisation that exists within Australia’s labour market.

In the absence of an unexpected acceleration in wages, or reversal of recent price trends in discretionary areas and housing, it’s difficult to see a substantial lift in inflationary pressures arriving anytime soon, especially given the evidence seen in other advanced economies where labour market conditions are far tighter than Australia.

As the RBA has pointed out in recent months, progress in boosting inflationary pressures will be “gradual”. If Westpac is on the money, it could well be glacial.

Regardless, with inflation soft, labour market underutilisation high and home prices in Australia’s largest cities falling, the last thing the Australian economy needs right now is a preemptive increase in the cash rate, especially given heightened uncertainty about the outlook for the global economy.

Such a policy response risks slowing economic activity and employment growth, two key pillars the RBA is banking on to help achieve its inflation mandate in the period ahead.