April 20, 2021

AMW: Inflation?

The signals to watch to see if central banks are right or wrong.

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  • Central banks (including the RBA) have been clear that they will look through temporary increases in inflation from base effects and supply chain disruptions. How will we know if central banks are right (or wrong) and the increase in inflation is indeed temporary? US Fed Vice-Chair Clarida said recently: “if inflation at the end of the year has not declined from where it is in the middle of the year that will be some good evidence” that the Fed’s current outlook is wrong.
  • In the meantime, what indicators can we look at to reassure ourselves that any pick-up in inflation indeed will be transitory? Or alternatively, if such a rise could prove more durable. We take three approaches:


    1. Look at what central banks and treasuries have said and why they believe inflation will be transitory. The major reasons cited are base effects, supply chain disruptions easing as supply rebounds, limits on how many services an individual can consume (e.g. haircuts), and anchored inflation expectations.
    2. Summarise components of the CPI basket most sensitive to labour market conditions (termed cyclical) and those that aren’t (termed ‘acylical’) into separate measures to identify the sources of inflation pressures. Here we replicate the San Francisco Fed’s “Cyclical and Acyclical Core PCE Inflation ” and find that around one-third of the CPI basket in Australia is sensitive to labour market conditions. We should be able to use this cyclical inflation measure to assess whether any prospective lift in inflation is temporary. Notably rents, restaurant meals and hairdressing have high weights in this measure, and inflation trends in these areas are running below average, though the pandemic had obvious effects in each area of spending.
    3. Summarise components of the CPI basket most sensitive to the initial COVID-19 shock. Here we replicate the San Francisco Fed’s “Inflation Sensitivity to COVID-19 ” and apply it to an Australian context. Around half of the CPI basket saw sizeable price or quantity changes, including decreases in domestic travel, sports participation and clothing items and it is likely we will see some price rebound in these categories going forward.  Importantly for underlying pressures, non-COVID sensitive items have seen inflation ease.

The week ahead

  • Australia: Retail Sales on Wednesday is the only significant data point in a quiet week for data. NAB has pencilled in a 1.4% m/m rise, slightly more than the 1.0% consensus. The RBA Minutes are also on Tuesday but are unlikely to contain new information.
  • International: NZ: Q1 CPI will be watched closely on both sides of the Tasman given Australia’s Q1 CPI the following week. US: Earnings season continues with IBM on Monday and Netflix on Tuesday the first of the tech names; EZ/UK: global PMIs on Friday the one to watch along with the ECB on Thursday.

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