UBS: Australian inflation's going nowhere - and interest rates will do the same

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After years of constant disinflation – in some cases outright deflation – global inflationary pressures are now picking up, driven by a combination of low base effects stemming from previous price declines and a clear improvement in economic conditions.

The global economy is reflating before our eyes.

As a small, open economy highly dependent on the rest of the world for its own economic prosperity, some expect that will lead to better times ahead for Australia, seeing both GDP growth and inflation accelerate sharply in the year ahead.

That, in turn, will lead the RBA to lift rates, perhaps before the end of this year, more optimistic forecasters say.

However, not everyone expects shares that view – or at least at the pace suggested.

UBS’ Australian economics team of Scott Haslem, George Tharenou, Joakim Tiberg and Jim Xu, are among them, suggesting in a note this week that underlying inflationary pressures in Australia will remain benign in the year ahead.

“Our analysis suggests that while pass-through from higher world prices is an emerging risk, we argue Australia’s structural disinflationary forces not only remain in play, but have intensified,” they wrote.

“Wage growth has trended lower, competition and regulatory pressures have broadened, while housing rent (& construction) costs have further to slow.

“Our analysis again raises the risk inflation may stay below the RBA’s target band for longer.”

UBS sees underlying inflation, also known as core inflation, remaining below the RBA’s 2-3% underlying inflation target until mid-2018, some six months later than what the RBA is currently forecasting.

Even when it does get back to the bottom of the band, UBS doesn’t see if getting significantly higher by the end of 2018, suggesting that it will remain at a paltry 2.1%.

As a result, it thinks the RBA may trim its near-term underlying CPI forecasts in its upcoming Statement on Monetary Policy, scheduled for release on Friday, February 10.

That would come as a shock to many in financial markets should it eventuate, particularly with the RBA currently forecasting that underlying inflation will sit between 1.5% to 2.5% for the entirety of this year.

While UBS doesn’t expect that will herald a near-term rate cut, it says that will keep the RBA on the sidelines for at least the next 18 months.

“Against forecasts by some for near-term rate cuts and by others for multiple hikes from early 2018, we retain an on-hold rates outlook until at least mid-2018, targeting a late-2018 start to RBA normalisation.”

The view offered by UBS is certainly more dovish than their rivals at Goldman Sachs who expect the Reserve Bank of Australia to start raising interest rates in February 2018, with risks building for an even earlier hike.

Surging commodity prices are “transformational” for Australia’s broader economic outlook, the bank’s economists led by Tim Toohey said. The price rally puts the economy on track to record the largest trade surpluses since the 1970s, which could boost the Australian dollar in the near term and pave the way for increase in private demand, they said.

Goldman sees three rate rise from the RBA in 2018. Tim Toohey, head of macro research in Australia and New Zealand, thinks the RBA’s tightening cycle could start even sooner, seeing a 40% chance of a rate hike as early as November this year.

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