On what is a quiet data week, there’s one domestic event that stands out head-and-shoulders above the rest: Australia’s September quarter consumer price inflation (CPI) report, due on Wednesday.
It’s proven to be a major market mover already this year, with the Reserve Bank of Australia (RBA) cutting rates in May and August following the release of the previous two CPI reports.
Given that track record, there’s going to be plenty of eyes on the core inflation figure, and likely a bout of market volatility, when the ABS figures hit the screens at 11.30am AEDT.
Like many others ahead of this important release, ANZ’s currency and interest rates strategy team, including Katie Hill, Daniel Been and Martin Whetton, have been looking at not only how the core CPI figure is likely to print — that most important to monetary policy settings — but also how financial markets will react.
Perhaps understandably given its recent track record, the trio say that “the stakes are high this week” for both the Australian dollar and the outlook for Australian interest rates.
While no one can say with certainty as to how the core CPI figure will print, Hill, Been and Whetton have produced an excellent guide explaining how they expect markets will react to a lower, in line and hotter-than-expected figure on Wednesday.
It’s an invaluable guide, not only for those trading around the event but also investors, households and businesses who will be impacted by the data in the period ahead.
Here’s ANZ’s view on what to expect if the quarterly core CPI figure comes in below market expectations which are currently looking for an increase of 0.4%. That’s followed by it’s expectations for an in line print, and if it comes in well above forecasts.
Core reading of 0.3% or below
A print of 0.3% q/q or below for the average of the core measures would be considered weak and suggest that disinflationary pressures have not based.
We would expect a rally in the front end of the curve to price in 20-25bp of cuts over the next year. The OIS curve would likely flatten from February with more priced into 2017 RBA OIS dates given our economists’ view that the chance of a November cut is low due to the better tone to domestic growth, renewed momentum in Sydney and Melbourne house prices, the global inflation pulse and the RBA’s greater emphasis on financial stability. Broadly, we would expect the Australian front end to take a similar approach to the US recently, pricing one move at a time.
For the AUD, we would expect a relatively sharp reajustment, setting it up for a re-test of the 200 DMA at USD0.7460. AUD/NZD would be particularly vulnerable to this outcome given that New Zealand core inflation showed further signs of basing in Q3.
In line reading
A consensus-like, 0.4-0.5% q/q result is effectively the ‘grey area’ for markets. This would give the RBA some comfort that disinflationary pressures are basing. We expect it would not alter the balance of risks and therefore be a non-event for markets. As such, our bias in the event of a market move on a number within this range would be to fade it.
If underlying inflation is 0.6% q/q or above, the makeup of inflation will likely be more important than usual.
If the detail is soft, we would expect the initial market move could be fleeting.
If the detail was strong and suggested there is broad-based strength across non-tradable inflation, we would see the front end further reduce pricing of cuts with the possibility of mid-to-late 2017 RBA dates pricing in a hike. The AUD would re-test USD0.7720 in the following days.
On the crosses, we would expect AUD/CAD to outperform, given the soft CPI print in Canada on Friday and rising expectations of easing from the BoC. AUD/EUR would also particularly benefit given expectations of a QE extension at the December ECB meeting.
While ANZ has only covered the scenarios that are most likely to occur, it believes that a quarterly core inflation number of 0.7% or higher would risk seeing Australian interest rate expectations shift to pricing hikes, rather than cuts, as is currently the case.
This, it says, is not its “base case” scenario, although acknowledges that a “big shift in the trajectory of inflation in Australia would threaten both our view that the market will not move to price in hikes into the OIS strip, and that the AUD remains capped”.
Economists at ANZ are forecasting a quarterly increase in core CPI of 0.4% — the same as the median market forecast — leaving the year-on-year increase at 1.5%, in line with forecasts offered by the RBA.
Ahead of Wednesday’s report, cash rate futures put the odds of a 25 basis point rate cut being delivered by the RBA in November at around a one in five chance.
As shown in this chart below from ANZ, overnight index swap (OIS) pricing looking one year ahead is around 10 basis points lower than where the cash rate currently sits at 1.5%, implying that why there’s still an expectation that rates will be cut further in the year ahead, it’s now seen as less likely outcome than them being left unchanged.