What economists say about Australia’s inflation report

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Australian inflationary pressures remain ice cold, eking out another tiny increase in the June quarter.

According to the ABS, headline inflation rose by just 0.2% — half the rate expected — leaving it up 1.9% from a year earlier.

Core inflation — that which strips out volatile price movements during the quarter and of far more importance in terms of the outlook for monetary policy settings from the RBA — was a little stronger, rising by 0.53%, leaving the year-on-year increase at 1.84%.

That was a little hotter than the 1.75% pace both the RBA and markets were expecting.

Despite the progress on bringing core inflation rate back to within the RBA’s 2-3% medium-term target, financial markets bought bonds and sold the Australian dollar in the wake of the report, adopting the view that the weakness in both inflation measures does not alter the view that interest rates will be left unchanged for sometime yet.

Now that they’ve had time to digest the report, it’s time to see what Australia’s economic community has made of it all.

Does it merely solidify the steady-as-she-goes outlook for rates, or is there something lurking beneath the surface?

Let’s find out.

Jo Masters, ANZ

While headline CPI rose well below market expectations, core measures were in line with both market expectations and the implied forecasts from the RBA’s most recent SoMP. On a variety of measures, core inflation pressures have stabilised and even nudged a touch higher. In six month-end annualised terms, core inflation is now at 2.1%. We continue to expect only a gradual acceleration from here, however, given the outlook for wages, retail competition and the housing sector.

For the RBA, the core inflation readings are encouraging. Core inflation has stabilised on an annual basis, and turned up on a six-month end annualised. Our forecasts, though, suggest that any acceleration from current levels will be gradual and we continue to see core inflation in year-on-year (YY) terms sub-2% until late 2018.

While we remain comfortable with the view that the RBA is on hold, the balance of risks — which we previously saw as tilted to the downside — looks to be becoming more balanced.

Shane Oliver, AMP Capital

The Australian economy is still experiencing below-trend growth and spare capacity in the labour market. This ongoing spare capacity means that price growth for goods and services will remain constrained. Over the near-term, 20% plus electricity price hikes will be a big driver of higher headline inflation but the flow through to underlying prices may not occur for a few quarters and may actually work to push underlying inflation down as discretionary spending power is reduced. And petrol prices still remain constrained and the higher Australian dollar will work to put downward pressure on imported prices.

While the broad set of activity data has improved in Australia over the second quarter, there are still reasons to remain cautious on growth — unhappy consumers, slowing housing construction and prices and some further drag from mining investment.

We think that below-trend growth and a soft inflation backdrop will keep the Reserve Bank on hold until the end of 2018 or even early 2019, when the improvement in the economy and a rebound in price growth will argue for a start towards the normalisation of interest rates.

Su-Lin Ong, RBC Capital Markets

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. Price increases in health, education, utilities, insurance, and housing continue to rise well above headline inflation. These trends are well established and are set to rise further in Q3. This cost-push inflation is likely to temper consumption and add to a number of challenges for households.

Today’s print was in line with the RBA’s forecasts for the quarter and suggests little change to its medium-term forecasts in next week’s quarterly Statement on Monetary Policy. While the details of the release suggest a weaker core inflation pulse, we suspect that the RBA will remain focused on the trimmed and weighted measures which annualise at the bottom of the 2–3% inflation target in the first half of 2017 and will hope that higher headline inflation ahead will eventually feed through more broadly.

We are less sure given the composition of inflation and the likelihood that wages/unit labour costs remain under some pressure to ensure competitiveness, especially if the currency continues to push higher.

We expect the cash rate to remain at 1.5% for the foreseeable future.

Michael Blythe, Commonwealth Bank

The Q2 outcomes were pretty much what the RBA expected to see. Cyclone Debbie had some impact on fruit and vegetable prices. Ongoing competition in the supermarket space kept the lid on grocery prices. There was the usual seasonal unwind of post-Christmas retail price discounting. Lower petrol prices helped. And annual rises in health insurance charges came through. The shortfall in the headline CPI relative to expectations mainly reflects strong competitive pressures in clothing and a supply side boost that dragged some fruit and vegetable prices lower.

The CPI offers some insight into the ongoing debate about high household debt and potential downside risks to consumer activity. Household perceptions about their financial position have deteriorated in recent years. And the perception has been accentuated by weak wages growth and the rapid growth in prices in areas that are largely outside consumer discretion such as fuel, health, insurance and utilities. Our calculations on the “pain spend” subset of the CPI show annual growth running at 3.3% per annum, well above the overall CPI basket.

We expect the RBA to be disappointed that headline inflation is again below target but reasonably comfortable with their current inflation projections. A stronger labour markets adds some support for the expected modest lift in wages. A stronger currency could see some modest trimming to the RBA’s near-term underlying inflation forecasts.

Ben Jarman, JP Morgan

There was little change in the underlying themes driving inflation. Goods inflation was weak (0.1% q/q) as the exchange rate tailwinds from AUD’s earlier decline are fading, and retail margins are compressing. Similarly tradables inflation has been negative in each of the last three quarters, despite generally supportive petrol prices.

Annual inflation is 1.5% YY ex-volatile items, and 1% YY excluding volatile items and administered prices. The proportion of CPI sub-groups running below 2% YY also stayed very close to its all-time high. Non-tradables inflation sequentially weakened to 0.4% QQ. Part of this is seasonal, though it still seems that the only thing propping up the annual rate in this segment is the housing group, particularly house purchase costs and utilities.

These soft dynamics in market-based prices confirm that excess capacity remains in both the goods and labour markets, and is having a broad negative influence. Given that we forecast growth to stay below trend, and unemployment above the natural rate over the next 18 months, the only prospects for lift in headline inflation come through energy costs and government charges.

Questions will be accumulating as to how inflation will get back to target over time given the spare capacity that clearly still exists. As the run of results below the bottom of the target extends, it will also be adding some downside risks to inflation expectations.

Annette Beacher, TD Securities

Underlying inflation — the RBA’s policy focus — took another small step higher from 1.78% YY to 1.84% YY, an outcome that is neutral for monetary policy and the markets. Headline inflation eased +1.9% YY, masking divergent trends in tradable and domestic inflation.

Our base case is for the RBA to begin removing outsized monetary accommodation by May 2018. By that time, the RBA will have had two more CPI reports to digest, eventually confirming that core inflation resides back within the RBA’s 2-3% target band.

We look for two 25 basis point adjustments next year, for a year-end cash rate target of 2%. This is still well below the RBA’s recent revelation that the new neutral cash rate is closer to 3.5%.

Kate Hickie, Capital Economics

The fall in headline inflation was not anticipated by most analysts. This decline was partly driven by a 2.5% fall in the petrol price, which compared with a 5.7% rise in the second quarter of last year.

It appears that the tough retail climate also played a role, as it prompted some firms to apply unusually large discounts to their clothing and footwear merchandise. Finally, fruit and vegetable prices fell unexpectedly in the second quarter despite the supply disruptions caused by Cyclone Debbie.

More importantly though, the 0.5% increase in an average of the trimmed mean and weighted median gauge of underlying prices matched the rise in the second quarter of last year and as such underlying inflation remained broadly unchanged at 1.8% YY. That was a touch stronger than the consensus and the RBA had expected.

Looking ahead though, we doubt this will mark the beginning of a sustained pick-up in underlying inflation given that GDP growth is likely to remain below potential again this year and next. Alongside the RBA’s financial stability concerns, this explains why we believe that financial markets have got ahead of themselves by pricing in the first rate hike for 2018.

We doubt the RBA will begin to raise rates until 2019.

Paul Bloxham, HSBC

Headline CPI inflation dropped back, but the overall picture remains one of low but gradually lifting underlying inflation pressure. The two major underlying measures were in line with expectations, at 1.8%, the strongest combined reading since Q4 2015. Non-tradable inflation also lifted to 2.7%, the highest in three years.

The weaker headline result was due to a drop back in tradable inflation largely driven, as anticipated, by lower petrol prices. The surprise was a continued decline in clothing and footwear prices, reportedly due to sustained discounting. Prices in this category have now declined by 1.9% over the past year. Competitive pressures and the stronger AUD are likely to maintain this deflationary trend.

Nonetheless, there was little else in the data to alter the RBA’s assumption of a gradual increase in underlying inflation over coming quarters. We expect that pattern to be supported by the end of the mining investment decline, along with the impact of higher commodity prices and the resulting lift in nominal growth. That should support a modest lift in wage growth, assisted by further gradual tightening in the labour market.

We expect the RBA to begin lifting its cash rate in Q1 2018.

George Tharenou, UBS

Inflation is still rising only “gradually” — as the RBA expects — but the key issue is underlying CPI remains below its target for a sixth consecutive quarter, which is the longest ‘undershoot’ on record. While the market saw the RBA minutes commentary on ‘neutral’ rates as hawkish, and an energy price spike will also push up Q3 CPI, we see a housing correction, Amazon’s entry and technical re-weighting limiting inflation through 2018.

So while there is better global growth & domestic jobs, we still see the RBA waiting to normalise rates until the second half of 2018.