CPI inflation is below expectations for the seventh quarter running: Justin Smirk

EXPERT OBSERVER

For the seventh quarter in a row inflation has underperformed market expectations with the headline CPI lifting 0.4% in the quarter compared to an median expectation of 0.5% qtr.

Westpac’s forecast was for 0.4% qtr.

Interestingly the mix of sectors prices was broadly as we had expected with some small downside and upside surprises but the overall print was slightly to the downside of our expectations.

At two decimal places the CPI rose 0.36% in the quarter while our forecast was 0.42%.

Following the December quarter CPI Westpac argued that searching for inflation in the Australian economy has been a fruitless as Vladimir and Estragon’s wait for Godot.

We are now looking at the play having a record run with the ABS for while there may be some anecdotal hints that inflation is around, the ABS is yet to report its appearance in any solid form in the CPI Survey.

Core inflation came in as expected rising 0.5% qtr (0.46% at two decimal places so a soft 0.5%) suggesting that Australian forecasters, as a group, are broadly getting the core inflation pulse corrected but continue to underestimate the deflationary pulse that is hitting certain sectors leading to greater than usual discounting (or less than usual post sales repricing) in those sectors.

The six month annualised pace of headline inflation printed 1.6%yr, down from 2.2%yr in Q1 and the recent peak of 2.5%yr in Q4 2017.

For core inflation, the six month annualised pace is now 2.0%yr from 2.0%yr in Q1, 1.7%yr in Q4 2017and 2.0%yr in Q3.

With core inflation just at the bottom of the RBA’s target band, inflation remains well contained at a very modest pace. This would leave the RBA quite comfortable with the current stance of monetary policy.

Without a doubt the Australian economy remains locked in a low inflation environment. Sectors that are experiencing some inflation –particularly tobacco and auto fuel then to a lesser extent, housing, health and education – are mostly being offset by the disinflationary pressure of the competitive squeeze in consumer goods. There are no signs we are about to experience a broader upswing in prices that you would normally expect to see at this late stage of an economic recovery.

Breaking it down a bit further prices came in broadly as expected with a mix of upside and downside surprises. However, given that the two decimal place print from the CPI was just 0.36%, compared to our forecast for 0.42%, then overall there was a very modest downside surprise in the survey.

Food prices were a touch softer than expected falling 0.4% vs our –0.2% forecast with a larger than expected fall in fruit & vegetables (–2.7% vs –0.5%). Alcohol & tobacco was stronger than expected (1.6% vs 0.6% expected) with a robust 2.8% rise in tobacco prices.

Clothing & footwear came in as expected with a 1.3% seasonal re-pricing while housing costs were close to expectations rising 0.2% vs 0.1% expected. However the mix was very interesting with rents flat (0.2% expected), dwelling purchase rose 0.8% (vs. 0.5% expected) while the fall in utilities was great than expected (–1.2% vs –0.9% expected).

An area where the downside pressure appear to be significant was the smaller than expected seasonal re-pricing for household contents & services (0.3% vs 0.8% expected) while health rose just 1.9% vs. the 2.6% expected this is despite a smaller than expected fall in pharmaceutical (–1.0% vs –1.6%)

Tradables rose 0.5% in the June quarter. Tradables goods rose 0.4% mainly due to automotive fuel (+6.9%qtr), audio, visual & computing media and services (+3.0%qtr), garments for women (+2.2%qtr), and glassware, tableware & household utensils (+3.5%qtr). The tradable services component rose 1.3%qtr due to international holiday travel and accommodation (+1.3%qtr) in response to peak period pricing for Europe and America. Tradables represent approximately 35% of the CPI.

Non-tradables rose 0.3% in the June quarter. Non-tradables goods rose 0.7%, mainly due to tobacco (+2.8%qtr), new dwelling purchases by owner occupiers (+0.8%qtr) and takeaway and fast foods (+0.8%qtr). The non-tradable services component rose 0.2%, mainly due to medical and hospital services (+3.1%qtr) and child care (+1.0%qtr). Non-tradables represent approximately 65% of the CPI.

Low inflation remains embedded in the economy.

We have seen inflationary expectations drift a little higher (we suspect rising fuel prices and until this year, rising power bills are responsible for this) but despite this the ABS CPI Survey again revealed little to suggest that the Australian economy is about to break out of its low inflation trap.

Through 2017, the big story was the rise in energy bills, particularly for electricity but also gas. However, in late 2018 there was a significant change in the wholesale electricity market as the expansion of renewable generation exceeded expectations, and power storage facilities enter commercial application, driving down wholesale prices. Some modest discounting of power bills has been reported and we are expecting this to continue through the remainder of 2018 and into 2019 which was a key reason for the recent downgrade to our inflation profile, for both headline and core, out to the end of 2019.

We will provide a full update on our forecasts in the CPI Economic Bulletin but at this stage, given that the run of soft updates that point to the Australian economy being in a low inflation trap, the risks to these forecasts still lie to the downside.

Justin Smirk is a commodity analyst for Westpac