Australian inflationary pressures remained subdued in the final three months of 2016 with both headline and core consumer price inflation (CPI) undershooting market expectations.
According to the ABS, headline CPI rose by 0.5% during the quarter, below the 0.7% increase expected. It previously grew by 0.7% in the September quarter.
Despite the weaker-than-expected quarterly figure, the year-on-year rate ticked up to 1.5% from 1.3% in Q3, although it too was below the 1.6% increase expected.
The ABS said that from a year earlier, tradables prices — largely influenced by global forces — rose by 0.1%, well below the 2.1% increase recorded in non-tradables prices — those influenced by domestic factors — over the same period.
Like the headline inflation figure, core inflation also undershot market expectations, rising 0.4% for the quarter against forecasts for an increase of 0.5%
Despite the softer-than-expected quarterly outcome, upward revisions to prior data saw year-on-year rate print at 1.55%, marginally ahead of the 1.5% increase expected. The core inflation figure is of more importance to financial markets given its relationship to movements in Australian interest rates.
While very soft — yet again below the RBA’s 2-3% medium-term core inflation target — it was in line with the most recent forecasts offered by the RBA in its November statement on monetary policy.
Has it really killed off the prospect of any further rate cuts, or is there still a case to ease further?
Here’s what leading Australian economists are saying. We’ve added emphasis in some places.
Jo Masters, ANZ
The inflation data suggest that the sharp disinflationary forces that have been weighing on prices are abating and that inflation is stabilising. Headline CPI was in line with our expectations at 0.5% q/q, while underlying inflation was a touch weaker at 0.4% q/q. This data is consistent with the RBA’s forecast profile and has no immediate policy implication. While the stabilisation in inflation would be welcome, we continue to see inflation running below the policy target band until the second half.
Underlying inflation appears to have stabilised. In six month-end annualised terms, core inflation was 1.7% in Q4 2016, compared with 1.5% in Q2 2016. The average of the two underlying measures rose 0.4% q/q, to be 1.6% higher over the year, while CPI ex volatiles (seasonally adjusted) was a touch weaker, up 0.3% q/q.
The ANZ diffusion index confirms that inflationary pressures remain soft across a wide range of items, with just 37% of items in the basket rising by more than 2.5% annualised – although this was up from 31% in Q3 2016.
Gareth Aird, CBA
CPI figures confirm that the pulse of inflation in Australia remains weak. But inflation picked up a little over H2 2016, albeit that it still sits below the RBA’s target band. The modest 0.4% rise in the underlying rate was a touch below market expectations for a 0.5% rise (CBA in line with consensus). But a small upward revision to the QIII data saw the annual underlying inflation rate print in line with market expectations. More importantly, the annual rate of underlying inflation is right in line with RBA forecasts which, in our view, keeps a rate cut off the table next week.
Smoothing out the bumps shows that underlying inflation was running at an annualised pace of 1.7% over the past two quarters. This looks like a fair approximation of the current inflation pulse. And it is consistent with the tepid pace of wages growth. It does, however, look like the slowdown in inflation has come to an end which supports market pricing that 1½% is the low point for the cash rate.
Firmer commodity prices, a very gradual tightening in the labour market and a lift in both domestic and global inflation expectations suggest that core inflation bottomed out in QIII 2016. The annual headline inflation rate looks to have hit its cyclical low point in QII 2016 at just 1.0%. That said, we don’t expect inflation to pick up materially in 2017 and essentially have the annual rate of underlying inflation tracking sideways in a narrow 1½ 1¾% range throughout the year.
The detail behind today’s CPI outcomes confirm that inflation risks remain well contained. But they are also consistent with our view that inflation is unlikely to slow further from here.
Very weak inflation readings for H1 2016 underpinned the RBA’s decision to ease policy in May and August last year. At the time, the unemployment rate was trending down and growth outcomes were decent. We very much doubt that rates would have been cut had it not been for the particularly soft inflation readings. As a result, market participants became fixated on the inflation prints throughout 2016 and the activity data took a back seat. That has since changed.
We think that the RBA faces a tough job in returning inflation to target. And we don’t expect core inflation to get back to within the target band until 2018. But in our view, the hurdle for another rate cut is higher than it was last year. With the Fed tightening further in 2017, public infrastructure spending lifting and continued strength in the housing market, we see the RBA content to leave rates on hold despite inflation undershooting the target. The risk, however, sits with easing over the next six months. And in our view, talk of a rate rise is premature.
Shane Oliver, AMP
The Australian fourth quarter 2016 inflation data was a little softer than expected. Both headline and underlying inflation remain below the RBA’s 2-3% inflation target band (see chart below), imparting a bias to cut interest rates again.
Annual inflation at 1.5% in the December quarter is line with the RBA’s own forecasts, but record low wages growth and spare capacity in the economy (with GDP growth now running well below average) mean that underlying inflation is likely to take longer than the RBA is allowing to get back to its 2-3% inflation target band. We expect that continued weak inflationary pressures along with a downwards revision to the RBA’s growth forecasts following last September quarter’s contraction in GDP will force the RBA to cut the cash rate again by 0.25% taking it to 1.25%. A February rate cut looks unlikely at this stage – the labour market is holding up and the RBA may want to monitor the recent uptick in investor loan growth because of the risk to financial stability. But we think a rate cut is likely in May, following the next set of inflation data.
Su-Lin Ong, RBC
A benign Q4 inflation report all round which confirmed annual core inflation well entrenched below the floor of the RBA’s 2–3% target range. Broadly in line with the RBA’s own forecast, the latest Q4 print and its details will see no change to its near- or medium-term inflation forecasts in the upcoming February Statement on Monetary Policy (SoMP). Midpoint inflation forecasts are likely to be stuck at 2%, with likely downward revisions to GDP implying a mild easing bias. There is no trigger to exercise that bias anytime soon, but that may well change as the year unfolds, especially if inflation proves stubbornly low.
As has been the case for a number of quarters, it is the details of the CPI report that confirm a particularly benign inflation picture. More importantly, the key leading indicators of inflation—wages, unit labour costs, import prices—suggest little in the way of sustained price pressures anytime soon and are consistent with ongoing spare capacity in both goods and labour market. In particular, nominal unit labour costs which feed into inflation over 4–6 quarters remain low with y/y growth at just 0.6% and only just lifted out of negative territory in Q3 2016.
For the RBA, today’s inflation data were largely in line with its forecasts, but the longer inflation prints sub target, the less comfortable it will be. There will be no changes to its midpoint sub target inflation forecasts all the way out to the end of 2018 in the February SoMP but likely downward revisions to GDP given the weaker starting point for growth suggest that these inflation forecasts may err on the optimistic side. Without doubt, this implies a mild easing bias despite the lack of clear guidance. Indeed, there is no obvious trigger near-term to exercise this bias, with housing market strength (both activity and prices), niggling financial stability concerns, and resilience in commodity prices likely to keep the RBA on the sidelines for some time. It may, however, be a different story as we approach the peak of this residential construction upswing, consumption remains patchy and inflation stubbornly low. In our view, the market is a little complacent around the risk of further easing later in 2017. Price action post the data were consistent with this, with bonds rallying 2–5bp across the curve led by the front end and AUD/USD dropping around half a cent.
Paul Bloxham, HSBC
Today’s Q4 inflation numbers were a slight downside surprise to the market expectation, but were broadly in line with RBA’s own forecasts.
We expect underlying inflation to gradually climb from here, as the recent rise in commodity prices boosts incomes and flows through to support for domestic wages and inflation. We expect the RBA to be on hold in coming quarters and expect rate hikes in 2018.
The numbers also suggest that inflation may be past its trough. Underlying inflation has stabilised at around 1.5-1.6% for the past four quarters. On a q-o-q basis, the past three quarters have printed at 0.5%, 0.4% and 0.4%. If the next print is in line with this trend, then y-o-y underlying inflation will lift.
In addition, non-tradable inflation (which is the domestically driven part) has lifted over the past couple of quarters and appears to be past its trough. Non-tradable inflation rose to 2.1% y-o-y, up from a trough of 1.6% y-o-y in Q2 2016. The 0.8% q-o-q lift in non-tradable prices was the strongest in seven quarters. However, tradable or imported inflation remains subdued, and may remain so if the AUD maintains its current level.
We also see the recent rise in commodity prices as likely to support a modest pick-up in underlying inflation through 2017. The rise in commodity prices is expected to lift nominal income growth, corporate profits, tax revenue and to flow through to wages growth and inflation. There is a strong positive correlation between commodity prices and unit labour costs in Australia.
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