[CommSec Research]Surging oil price drives business inflation higher

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Surging oil price drives business inflation higher

Producer price index

• The broad measure of business inflation – the producer price index (PPI) – rose by 1.2 per cent in the March quarter, above expectations for an increase of 1.0 per cent. Compared with a year ago, producer prices were up by 2.9 per cent – marking the highest annualised reading in two years.
• Inflation was largely driven by price increases for domestically produced items with rises in the prices received for petroleum refining (+12.7 per cent) and electricity, gas and water (+2.7 per cent).
• The rising Australian dollar resulted in prices of imported goods falling by 0.3 per cent in the March quarter to be 3.9 per cent lower over the year.

What does it all mean?

• The latest business inflation result was modestly above expectations, however more importantly it was narrowly based in the March quarter. On the domestic front, contributing most to the inflation story was a rise in the prices of petrol refining, agricultural products, and a pickup in utility charges like electricity, gas and water. And given the lack of momentum in the economy it is unlikely that businesses will be able to pass through all the increases in costs. In fact it is more likely that cost increases are partially absorbed by businesses until activity picks up.
• As we have highlighted on many an occasion, the market is underestimating the impact that the higher Australian dollar is having on imported inflation. Prices on imported goods fell 0.3 per cent in the March quarter to be down 3.9 per cent over the year. In fact in annualised terms imported prices have been falling for 18 months – effectively offsetting domestic inflationary pressures. And given that the Aussie is expected to remain well above parity in coming months, imported inflation will continue to be tame.
• The ultimate concern is where prices go from here. The rebuilding of Queensland will add further pressure to an already tight labour market. But interestingly from a construction perspective price pressures were relatively benign, construction costs rose just 0.1 per cent in the March quarter to be up 2.1 per cent on a year ago.
• The consumer price data is released next Wednesday and it is likely that the underlying – excludes volatile factors – measures are likely to show a tame inflation environment. CommSec expects the underlying rate may have only risen by 0.6 per cent, keeping annual growth in the lower end of the 2-3 per cent target band near 2.1 per cent – a result that should ensure that the Reserve Bank policymakers will be able to stay on the interest rate sidelines well into the second half of the year.

What do the figures show?

Producer prices:

• Final stage producer prices rose by 1.2 per cent in the March quarter, ahead of expectations for a rise of 1.0 per cent. Producer prices were up 2.9 per cent on a year ago.
• Prices of domestically produced goods and services rose by 1.4 per cent to stand 2.9 per cent higher than a year ago. And prices of imported goods and services fell by 0.3 per cent to be 3.9 per cent down on a year ago.
• The ABS reported that final stage prices were driven by “rises in the prices received for petroleum refining (+12.7%), other agriculture (+13.7%) and electricity, gas and water (+2.7%). Partly offsetting these rises were falls in the prices received for commercial fishing (–7.6%).”
• Consumer good prices rose by 2.4 per cent in the quarter while capital good prices rose by 0.1 per cent. Over the year, prices of consumer goods rose by 4.8 per cent, while capital goods rose 1.4 per cent.
• Prices of intermediate goods rose by 2.3 per cent in the quarter to stand 4.4 per cent higher over the year. Preliminary stage materials rose by 2.6 per cent in the quarter to be 4.4 per cent higher than a year ago.
• Prices of building materials rose by 0.1 per cent in the March quarter and were up 2.1 per cent on a year earlier. Real estate agent fees rose by 1.5 per cent in the March quarter to be 6.7 per cent higher than a year ago.

What is the importance of the economic data?

• The Bureau of Statistics releases a range of measures on producer prices each quarter all contained in the one publication. Indexes cover manufacturing, mining, construction, transport and property and business services. Overall producer price measures are divided into components reflecting the stage of processing - final, intermediate and preliminary (raw) commodities. There are also separate producer price components for domestic and imported goods.
• The producer price figures are important in flagging price pressures at an early stage. If business costs are rising, the risk is that these will be passed on in terms of higher prices of final consumer goods. The Consumer Price Index is regarded as the key gauge of economy-wide inflation.

What are the implications for interest rates and investors?

• The one thing that is clear from the latest producer price data is that business inflation is relatively contained apart from a few categories. Reserve Bank policymakers are unlikely to be alarmed. The strength of the Australian dollar will support a low inflation environment while at the same time slowing activity in an array of sectors.
• CommSec expects a 1.3 per cent lift in the consumer price index, with the annual inflation rate rising from 2.7 per cent to 3.1 per cent. However the more closely watched underlying rate of inflation may have only risen by 0.6 per cent, keeping annual growth in the lower end of the 2-3 per cent target band near 2.1 per cent.