Below trend growth to continue
The quarterly inflation print is the most important statistic for financial markets in Australia. Several reasons why. First and most importantly the RBA is an inflation targeting central bank and this is their quarterly scorecard.
Since 1993 when inflation targeting began, about half of the RBA rate moves have occurred in February, May, August, or November. These months come immediately after the quarterly inflation print.
The second reason is that because we and the RBA don’t get to monitor inflation developments on a higher frequency monthly basis, the chances of us being surprised by the once a quarter shot from the ABS goes up significantly – it still amazes me that we don’t have a monthly CPI in Australia.
So Wednesday’s Q2 print outcome will be keenly watched. NAB’s forecast is that underlying inflation, the RBA’s preferred measure, rose +0.6%/2.7% in Q2. The consensus of economists is split on the two underlying measures and the average expectation is a little higher at +0.65%. The forecasts in the RBA’s Statement on Monetary Policy implies an outcome around +0.6/+0.7%. As petrol prices fell in Q2, we expect the headline inflation rate rose a more modest 0.4%/2.9%.
So with all that big talk on the importance of the inflation data, I now want to say that Wednesday’s Q2 print should matter less.
Bottom line is that the inflation outlook is not an issue, nor a trigger point, for the RBA right now.
If we get an upside surprise I expect the RBA would look through this to the broader drivers of inflation which remain benign – they did this when they got the surprisingly high Q4-13 inflation print and were justified in the “look through” by the subsequent low print in Q1-14.
Trends in the unemployment rate (high), wages (lower), productivity (improving), and the $A (still high) all point to inflation moderating ahead. NAB’s medium term inflation forecast sees underlying inflation falling from 2.7% yoy in Q2 2014 to 2.1% by Q2 2015.
A downside surprise on Wednesday would be a pleasant outcome and endorse the RBA’s current view that inflation will be contained in the medium term. But in itself it would not be a trigger for the RBA to cut again. As we see it, a benign inflation outlook is a necessary but not sufficient condition for the RBA to cut again. The other conditions are 1) that the economy to be soft (likely); and, 2) for house/asset prices to stop rising (little evidence of this yet).
While a +0.6% or lower inflation outcome would not be a trigger for a RBA rate cut it would validate current market pricing which now puts a 60% probability on the RBA cutting 25bps by the end of 2014. This current market pricing aligns with where NAB sees risks for RBA policy ahead – most likely on hold at 2½% for a long time but the risk is they may still need to cut again.
A busy week in Australia, with the RBA Governor speaking tomorrow and the CPI Wednesday. Offshore, the RBNZ is expected to hike 25bps again on Thursday (fully priced) but they might signal a pause after that. The US CPI on Tuesday and China “flash PMI are the pick of the rest of the bunch.
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