[CommSec Research]Inflation: RBA alert but not alarmed

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Inflation: RBA alert but not alarmed

Consumer Price Index; Weekly Petrol

• The main measure of inflation in Australia – the Consumer Price Index (CPI) rose by 1.6 per cent in the March quarter, well above economist expectations centred on a 1.2 per cent increase. The annual rate of inflation rose from 2.7 per cent to 3.3 per cent.
• Higher prices for fruit, vegetables, education, pharmaceutical and petrol were partially offset by lower prices for electrical and technology goods, clothing, footwear, recreation goods, milk, bread, cars, pork and beef.
• The Reserve Bank focuses on three “underlying” price measures – trimmed mean, weighted median and CPIX (CPI less fruit, vegetables, petrol and deposit and loan facilities). The trimmed mean rose by 0.9 per cent (2.3 per cent annual); the weighted median rose by 0.8 per cent (2.2 per cent) and we estimate that CPIX rose 0.7 per cent (2.6 per cent).
• The average of the Reserve Bank’s “underlying” measures of inflation – weighted median and trimmed mean – held at 2.3 per cent in annual terms.
• According to the Australian Institute of Petroleum, the national average Australian price of unleaded petrol fell by 0.5 cents per litre to 144.1 cents a litre in the week to April 24. In the near term pump prices are likely to track sideways as the strength of the Australian dollar offsets the sustained increase in global fuel prices.

What does it all mean?

• The latest inflation result is certainly on the high side of expectations, with the quarterly increase of 1.6 per cent marking the highest reading in a decade. However it is important to point out that the robust inflation result was largely driven by one off items like the higher food and vegetable prices due to the natural disasters, and seasonal rises in education fees as well as pharmaceuticals. Added to which there is not much the Reserve Bank can do about the recent surge in oil prices and the flow on effect to domestic pump prices.
• In recent times the Reserve Bank has commented that it is willing to look through the short term implications of the natural disasters and focus on the longer term outlook. The latest result is unlikely to make the Reserve Bank uncomfortable but certainly it will be more watchful in coming months. The Reserve Bank cannot afford to over react on just one set of numbers, especially given that in the near term the domestic economy lacks momentum, while the strength of the Australian dollar will continue to keep imported inflation low and curb Aussie export industries.

• Importantly last time round the underlying measures of inflation (excluding volatile items) probably understated inflation while this time the result was more than likely a little bit above. So on balance over the past six month’s underlying inflation was closer to 0.6 per cent a quarter. Even the annualised reading of underlying inflation posted at 2.3 per cent - suggesting inflation is still comfortably at the lower end of the Reserve Bank’s target band of 2-3 per cent.
• The domestic economy is expected to pick up speed in the second half of year and no doubt the concern for policymakers will be if the higher inflation reading becomes entrenched and feeds through the economy. There is no question that inflationary pressures will remain the hot button issue for the Reserve Bank over the midterm, and the key will be how quickly labour markets tighten up. However it is important to highlight that interest rates are already mildly restrictive and as such CommSec expects the Reserve Bank to remain on the interest rate sidelines well into the second half of the year.

What do the figures show?

Consumer Price Index

• The All Groups Consumer Price Index (CPI) rose by 1.6 per cent in the March quarter after rising by 0.4 per cent in the December quarter.
• In the March quarter 30 items were cheaper, 5 unchanged and 55 higher. The ABS notes that “The most significant price rises this quarter were for automotive fuel (+8.8 per cent), vegetables (+16.0 per cent), deposit and loan facilities (+4.6 per cent), fruit (+14.5 per cent) and pharmaceuticals (+12.5 per cent). The most significant offsetting price falls were for furniture (–6.2 per cent), audio, visual and computing equipment (–7.2 per cent), milk (–6.2 per cent), overseas holiday travel and accommodation (–1.6 per cent) and motor vehicles (–0.5 per cent).” The footwear and clothing index was at its lowest level since June 2000.
• The annual rate of inflation rose from 2.7 per cent in the December quarter to 3.3 per cent in the March quarter.
• Underlying measures of inflation were also higher in the March quarter. The weighted median measure rose by 0.8 per cent in the quarter, with the annual rate holding steady at 2.2 per cent – a ten year low. The trimmed mean measure rose by 0.9 per cent in the quarter with the annual rate rising from 2.2 per cent to 2.3 per cent. And CommSec estimates that the CPI excluding fruit, vegetables, petrol and deposit and loan facilities (CPIX) rose by 0.7 per cent in the quarter with the annual rate rising from 2.5 per cent to 2.6 per cent.
• Prices of tradables rose by 1.8 per cent in the March quarter, with higher prices for fruit, vegetables, automotive fuel, tobacco, and pharmaceuticals, partially offset by cheaper, motor vehicles, audio, visual and computing equipment and furniture. The annual growth rate of tradables rose from 1.6 per cent to 3.3 per cent.
• Prices of non-tradables rose by 1.4 per cent in the March quarter. Price increases for electricity, house purchase and take away and fast foods were offset by price for milk, domestic holiday travel and accommodation and telecommunication. The annual rate of non-tradables inflation fell from 3.5 per cent in the December quarter to 3.3 per cent in the March quarter.
• Tradable goods are those items whose prices are largely determined on the world market. Non-tradable prices are more affected by domestic economic conditions.

Petrol prices:

• According to the Australian Institute of Petroleum, the national average Australian price of unleaded petrol fell by 0.5 cents a litre to 144.1 cents a litre in the week to April 24. The metropolitan price fell by 0.5 c/l to 143.4 c/l, while the regional average price fell by 0.4 c/l to 145.5 c/l.
• Average petrol prices across states over the past week were: Sydney (up 0.9 cents to 144.9 c/l), Melbourne (down 0.2 cents to 143.1 c/l), Brisbane (down 3.9 cents to 142.2 c/l), Adelaide (down 1.9 cents to 137.3 c/l), Perth (up 0.2 cents to 144.4 c/l), Darwin (up 0.1 cents to 149.5 c/l), Canberra (down 0.7 cents to 146.3 c/l) and Hobart (down 0.2 cents to 149.2 c/l).
• The national average wholesale (terminal gate) eased by 0.6 cents a litre to 136.7 cents a litre today over the past week.
• Last week, the key Singapore unleaded petrol price rose by US$3.10 (2.4 per cent) to US$131.24 a barrel. In Australian dollar terms the Singapore gasoline price rose by a much more sedate $0.11 (0.1 per cent) over the week to $121.87 a barrel.

What is the importance of the economic data?

• The Consumer Price Index (CPI) is regarded as Australia’s premier measure of inflation. The CPI is published quarterly and measures price changes for a ‘basket’ of goods and services that dominate expenditure of metropolitan households. The “All Groups” index is the main focus, but other inflation measures are also published such as so-called ‘underlying’ measures. These include measures that abstract from price changes in volatile price items such as fresh food and petrol.
• The Reserve Bank aims to keep the headline inflation rate between 2-3 per cent over an economic cycle. If inflation is high and expected to rise, the Reserve Bank may elect to raise interest rates in order to constrain price pressures. Conversely, if inflation is low and expected to remain low, the Reserve Bank may elect to cut interest rates if it believes the growth pace of the economy is in need of strengthening.
• Weekly figures on petrol prices are compiled by ORIMA Research on behalf of the Australian Institute of Petroleum. National average retail prices are calculated as the weighted average of each State/Territory's metropolitan and non-metropolitan retail petrol prices, with the weights based on the number of registered petrol vehicles in each of these regions.

What are the implications for interest rates and investors?

• The simple fact is that the economy is going sideways, while consumers are remaining conservative and refusing to spend unless goods are on special. As long as consumers remain conservative and businesses have to shave margins to move stock then underlying inflation will remain low.
• The strength of the Australian dollar continues to push down prices of imported goods and services. Lower prices were recorded across a whole range of items, from household appliances, clothes, shoes, tools, sporting goods, and even cars. And the sluggish level of consumer activity will continue to see retailers discount heavily, passing on savings to consumers in coming months - keeping a lid on imported inflation.

• The Australian economy should pick up pace over the coming year, justifying a further lift in interest rates over the latter part of 2011. The floods around Australia and the resulting rebuilding phase have the potential to add to inflationary pressures in terms of building costs and sliding unemployment. The key will be how quickly labour markets tighten up. If wage inflation becomes an issue then the Reserve Bank would have to move on the rate front.