Will inflation return?

Principal Economist's View

 

Next week, the Australian Bureau of Statistics will release the March quarter CPI report. Unlike most other countries who release inflation data monthly, inflation in Australia is only measured once a quarter. For this reason, Australian CPI reports take on extra significance as they provide a key guide to underlying inflationary trends in the economy, with particularly important consequences for both monetary policy and bond market pricing.

QIC’s forecast is for the CPI to rise 0.5% over the quarter, pushing the annual inflation rate up from 1.9% to 2.0%. Our view is in-line with the median forecast of economists surveyed by Bloomberg. Furthermore, both ourselves and the market are expecting underlying inflation to remain benign, rising 0.5% over the quarter. While this is a touch higher than the 0.4% outturn in the December quarter, underlying inflation will remain below the RBA’s target band with the trimmed mean inflation rate forecast to be unchanged at 1.8% and the weighted median inflation rate forecast to ease from 2.0% to 1.9%.    

In terms of our bottoms-up forecast, we are looking for the following key trends to emerge from the CPI report:

  • Utilities costs are continuing to rise strongly, with our forecasts looking for a 3.4% gain over the quarter. This is largely due to higher prices in Victoria, as most other states lift prices in July rather than January. Based on announcements by retailers, Victorian electricity and gas prices are expected to have risen by around 14% over the quarter. According to our forecasts, nationwide utilities costs are expected to have jumped 10.5% over the past year.

     

  • Automotive fuel prices continue to rise, with prices expected to pick-up 2.3% over the quarter due partly to higher global oil prices. Over the past year, fuel prices are estimated to have advanced by 7.5%.

     

  • Alcohol and tobacco prices continue to rise, up an expected 0.9% in the quarter. This is slightly smaller than the gain seen in the prior two quarters as there was minimal change in tobacco excise this quarter and only a slight increase in alcohol excise rates. Annual inflation for alcohol and tobacco is forecast to remain elevated at 7.2% in the March quarter.

     

  • Food and non-alcoholic beverage prices are expected to be flat in the quarter, weighed down by falling fruit and vegetable prices.

     

  • Clothing and footwear prices are forecast to decline around 2% in the March quarter. January sales by retailers typically lead to price declines over the quarter, while ongoing heightened retail competition will also put further downward pressure on prices. Based on our forecasts, annual inflation for clothing and footwear is expected to fall from -3% in the December quarter to -3.6% in the March quarter.

     

  • Health costs are forecast to rise 2.4% in the March quarter, to be 4.4% higher over the past year. The March quarter experiences seasonally strong gains in health costs due to an annual reset in the Pharmaceutical Benefits Scheme.

     

  • Education costs are forecast to rise just under 4% in the March quarter due to annual increases in school fees.

     

Despite a few upward one-off factors, ongoing subdued wage growth will continue to constrain underlying inflation across most other categories.

Overall, we expect the CPI report will do little to change the consensus view that inflationary pressures remain limited in the Australian economy. Furthermore, with underlying inflation remaining below the RBA’s 2-3% target band, the data is expected to have little near-term monetary policy implications. The RBA is likely to remain on the sidelines until there is convincing evidence that underlying inflationary pressures are starting to firm. This evidence remains some way off.

With our forecasts close to market expectations, we see little implications from the CPI report for current market pricing. In our view, we would likely need to see a significant upside surprise to core inflation measures for the market to reassess its view that the RBA will remain on the sidelines until June 2019. Although we think the market has pushed out its expectations for the RBA too far, the CPI report next week is unlikely to prove a catalyst for the market to reassess its view. 

Table 1: Financial market movements, 12 April – 19 April 2018

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,693.1

1.1%

US

2.91%

7.4 bps

US Dollar Index (DXY)

89.94

0.2%

Nikkei 225

22,191.2

2.5%

Japan

0.04%

0.6 bps

USD-JPY

107.37

0.0%

FTSE 100

7,328.9

1.0%

UK

1.52%

6.4 bps

GBP-USD

1.409

-1.0%

DAX

12,567.4

1.2%

Germany

0.60%

8.5 bps

EUR-USD

1.235

0.1%

S&P/ASX 200

5,881.0

1.1%

Australia

2.79%

12.3 bps

AUD-USD

0.773

-0.3%

Source: Bloomberg

 

To read the full report, including the economic update by region, click here.

 

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