Over recent years the inflationary pulse in Australia has been subdued and has come in persistently below the 2-3% band targeted by the RBA. In response, the Board has elected to take a patient approach, based on the expectation that tightening labour market conditions will gradually drive inflation back to target. For now, the labour market data remains solid as highlighted by last week's robust update for March (see here), though we are still yet to see any meaningful lift in inflation. While labour market data appears to be the top priority for the RBA, inflation is not that far behind and the Board's patience may be starting to wear thin so today's report warrants close attention.
As it stands | CPI
In Q4, CPI on a headline basis lifted by 0.5%, which was the first time in 2 years that the quarterly figure was above the market forecast (0.4%), though the annual pace eased from 1.9% to 1.8% (expected 1.7%). The headline CPI figure is based on price changes to a fixed basket of goods and services from one quarter to the next.
Core CPI, which is the preferred measure of the RBA, is taken as an average of the trimmed mean and weighted median measures and excludes the impact of extreme price movements from quarter to quarter (for those interested in the technical details see the following from the ABS here). In Q4, core CPI posted a 0.37% rise that was a touch softer than the consensus for 0.45%. On an annual basis, core CPI was 1.77% and essentially in line with expectations.
As we look forward to today's release, data compiled by Bloomberg Australia shows that inflation is expected to have softened in the March quarter, mainly due to a sizeable decline in petrol prices while strong competition continues to weigh on prices in the retail sector. The other key contributor remains weakness in rents and in dwelling construction costs. On a headline basis, inflation is expected to come in at 0.2% in the quarter and 1.5% through the year. Interestingly, there is a broad range of estimates for today's outcome from 0.0% to +1.0% in the quarter and from 1.3% to 2.0% for the year, with some prominent forecasters sitting towards the lower ends of the ranges.
Looking at the core measures, the expectations for the trimmed mean are 0.4%q/q and 1.7%Y/Y and for the weighted median 0.4%q/q and 1.6%Y/Y. Averaging these projections, Core CPI is forecast to rise by 0.4% in the quarter with the annual pace easing to 1.65%. The range of estimates for the quarter is from 0.3-0.9% and 1.55-1.8% in annual terms.
What to look for | CPI
The RBA's April meeting minutes have made it clear that we need to keep a close watch on the trajectory of inflation. The specific measure in focus is the annual rate for core inflation (currently 1.77%). If, as expected, we see this figure soften and move further away from the 2-3% target band that would be an unwelcome development for the RBA. Recall that back in February the RBA lowered its inflation forecasts for the next couple of years to indicate that a return to target is not seen before the end of 2020 (see here). A soft print today could prompt another downgrade in next month's Statement on Monetary Policy and that situation would only strengthen the market's expectation for the RBA to ease in 2019.
For a detailed analysis of how the markets might react today, this excellent analysis from Chris Weston, Head of Research at Pepperstone, here is highly recommended.
One other aspect worth following, though of less interest from a market perspective, is the 'market goods and services ex-volatile items' measure -- effectively a proxy for private sector inflation. We know that over recent years inflation has predominantly been driven by areas where pricing is influenced by government policy, such as in alcohol and tobacco, utilities, health, education, and property rates, as shown in the chart, below. In Q4, we saw better detail as private sector inflation lifted by 0.7% in the quarter to its fastest annual pace in 3 years to a still soft 1.5% despite the easing in the headline CPI. Another increase today provides at least some evidence that the underlying inflationary pulse is improving.
As usual, our analysis of today's data will be posted shortly after it is released.
