Australia's December quarter inflation report is scheduled for release today at 11:30am (AEDT). Annual headline CPI is expected to remain around 3% with fuel and rising new dwelling costs post the HomeBuilder scheme the main contributors. Underlying inflation lifted inside the RBA's 2-3% target band for the first time since 2015 in Q3 and is likely to have firmed further to around 2.4%. A tighter labour market and higher inflation than currently forecast points to the RBA winding up its QE program in February, while it could prompt an earlier start to the hiking cycle.
As it stands | CPI
Headline inflation was 0.8% in the September quarter and 3% over the year, broadly in line with consensus estimates. Annual inflation eased from its elevated pace of 3.8% in the previous quarter where it was boosted by the reversal of pandemic-related price falls.
Underlying inflation picked up in Q3 and came in above consensus expectations. The trimmed mean lifted by 0.7% in the quarter, taking the annual rate up from 1.6% to 2.1% (vs 1.8% exp). The weighted median was also up at 2.1% (vs 1.9% exp) from 1.6% following a 0.7%q/q rise. This meant that for the first time since 2015, underlying inflation had cleared the lower band of the RBA's 2-3% target.
The main drivers of inflation in the September quarter were fuel and new dwelling costs. Automotive fuel prices lifted by 7.1%q/q and were 24.6% higher over the year reflecting the rebound in demand from the period of global Covid lockdowns in 2020. New dwelling costs lifted by 3.3% in the quarter as supply constraints pushed up labour and materials costs, while fewer government HomeBuilder grants being paid out due to the scheme ending earlier in the year led to an increase in developers' base prices.
With the Delta lockdowns in New South Wales and Victoria in place for much of the quarter, pandemic-related effects continued to influence inflation. Retail inflation was weighed by increased discounting as retailers sought to clear winter clothing inventory after the lockdowns reduced spending.
However, supply constraints were putting upward pressure on new vehicle and household goods prices. Meanwhile, services inflation had lifted to its fastest annual pace (1.9%) since 2015. Restrictions on dining during the lockdowns led to a fall in the use of voucher schemes introduced by state governments and this pushed up restaurant prices. Reduced demand from restaurants had weighed on fruit and vegetable prices (-3.5%) in the quarter.
Market expectations | CPI
The consensus for headline CPI is 1% for the quarterly rate, with the range of estimates between 0.8% and 1.2%. This would see the annual pace firming from 3.0% to 3.1%. As in Q3, fuel and new dwelling costs are likely to remain the main drivers of inflation. A post-lockdown rebound in spending could lead to more upward pressure on services inflation. Meanwhile, a reversal of weakness in fruit and vegetable prices is likely to drive a higher pace of food inflation.
For the underlying measures, the trimmed mean is forecast to rise by 0.7% in Q4, taking the annual rate from 2.1% to 2.4%, while the outcomes anticipated for the weighted median are 0.7%q/q and 2.3%Y/Y.
What to watch | CPI
Clear in the memory is the Q3 CPI report that led to significant reverberations in markets and RBA policy. The upside surprise on underlying inflation triggered a very aggressive repricing in the domestic bond market that ended up with the RBA abandoning its 3-year yield target a few days later at the November meeting. If it is now widely expected that the RBA will discontinue the QE program in February, the timing of the first rate hike is in focus.
Cash rate futures suggest this will come by the middle of the year, but Governor Lowe has pushed back against hiking in 2022 in his recent speeches on the basis that sustaining inflation in the 2-3% target band would require a tighter labour market and faster associated wages growth than the RBA was expecting.
However, as seen last week, with the unemployment rate falling to a 13-year low at 4.2% in December, the labour market was tightening much more rapidly than the RBA's forecasts. Those same forecasts show trimmed mean inflation to Q4 (2¼%) is a bit lighter than today's market consensus (2.4%). Should the market be vindicated, a tighter labour market and higher inflation than currently expected could see the RBA becoming more open to hiking in 2022.
