Another soft quarter of inflation

 

 Economist's View

The headline consumer price index (CPI) rose 0.4% in the September 2018 quarter, with year ended inflation decelerating to 1.9% (from 2.1% in Q2), settling back below the RBA’s 2-3% inflation target range. Both outturns were in line with QIC’s forecasts, although the market was anticipating a slightly stronger quarter outturn of 0.5%.

However, underlying inflation measures were slightly weaker than expected by both QIC and the market. The average of the weighted median and trimmed mean inflation rates for Q3 was 0.3% in seasonally adjusted terms (QIC & market: 0.4%), with a weaker-than-expected weighted median measure the main culprit.

This contributed to a weaker year-ended rate of 1.75% (QIC: 1.9%; market: 1.9%), though revised seasonal factors were also at play, resulting in downward revisions of year-ended underlying rates over the past year. There was some negative market reaction to the data, with the Australian dollar edging down about 0.4% from US$0.710 to US$0.707 following the release, before settling around US$0.7085. Australian 2-year and 10-year government bonds saw only very minor falls in yields immediately following the release.

A number of price movements were as expected; higher petrol prices and a tobacco excise hike provided some support, and the switch from previous child care benefit arrangements to the ‘Child Care Subsidy’ on 2 July resulted in an 11.8% fall in child care prices in Q3, subtracting 0.16ppts from quarterly inflation. Some other administered prices that have traditionally been a source of upward pressure on headline inflation, particularly electricity prices, were also more subdued in the third quarter compared with past years, as had been expected. Electricity prices rose just 0.4% in the September quarter, compared with an 8.9% gain in the corresponding quarter last year. As a result, year-ended inflation in electricity prices fell to just 1.8% in the third quarter from 10.4% in Q2.

The smaller rise in electricity prices contributed to the weaker-than-usual inflation in the broader housing group. The September quarter has traditionally been a period of strong price rises in this group, given the typically large share of price changes of utilities and property rates and charges falling in the quarter. However, quarterly inflation of 0.4% for the group was the lowest September quarter rise since 1998. Also contributing to subdued inflation in the September quarter were the health and education groups, two categories which have traditionally seen elevated price inflation for a prolonged period but where price growth has trended lower in more recent times.

Both the headline and underlying outturns are consistent with the RBA’s most recent forecasts of 1¾% year-ended inflation for both measures for the December 2018 quarter, outlined in the most recent Statement on Monetary Policy (SMP, August 2018). The RBA had also flagged for a number of months that inflation would be weaker than expected in the near term due to one-off changes in some administered prices.

Any detailed update to the RBA’s views on inflation will likely be communicated in the upcoming November 2018 SMP, which will be released next Friday, 9 November. However, the RBA is likely to look through the soft print, as has been flagged, and continue to forecast a very gradual recovery in headline and underlying inflation.

The September 2018 quarter inflation report suggests that a lack of significant inflationary pressures in the Australian economy continues to persist. Given the number of one-off factors weighing in the quarter, there is not likely to be any near-term implications for monetary policy.

However, with both headline and underlying measures of inflation below the RBA’s 2-3% target band, the RBA will continue to wait on the sidelines until there is convincing evidence that faster growth in wages or prices have firmly taken root. Nonetheless, inflation is expected to gradually recover, with some factors that have weighed on inflation starting to turn around.

A tightening labour market has resulted in a turnaround and signs of recovery in wages growth, while a lower Australian dollar should support tradeables inflation, in addition to higher oil prices. These effects are expected to gradually pass through and place upward pressure on both goods and services inflation over the next two years. This should be sufficient to lift both headline and underlying inflation above 2% by the second half of 2019, laying the groundwork for the RBA to consider raising interest rates.

Table 1: Financial market movements, 25 October – 1 November 2018

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,740.4

1.3%

US

3.13%

1.4 bps

US Dollar Index (DXY)

96.28

-0.4%

Nikkei 225

21,687.7

2.0%

Japan

0.12%

0.6 bps

USD-JPY

112.72

0.3%

FTSE 100

7,114.7

1.6%

UK

1.46%

1.4 bps

GBP-USD

1.301

1.5%

DAX

11,468.5

1.4%

Germany

0.40%

0.1 bps

EUR-USD

1.141

0.3%

S&P/ASX 200

5,840.8

3.1%

Australia

2.65%

3.5 bps

AUD-USD

0.721

1.8%

Source: Bloomberg

 

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