The good kind of inflation: HSBC's Paul Bloxham

The good kind of inflation: HSBC's Paul Bloxham
The good kind of inflation: HSBC's Paul Bloxham

Growth has been strong, but inflation is weak. This is an unusual combination.

Typically, strong growth sees a pick-up in domestic demand, which creates jobs and drives wages and inflation up.

Not this time.

Part of the reason has been that global inflation is low, but this is not the full story.

Australia's low inflation also reflects an unusual local cycle. The end of the mining boom has been long and drawn out, running for four years, so far.

Faced with falling commodity prices, which have weighed on national incomes, Australia's economy has adjusted with slower wages growth, down from 4% to 2% y-o-y. This has, in turn, delivered lower inflation.

In this way, we see low inflation as an element of Australia's rebalancing act, as growth shifts from being driven by the mining sector towards the housing and services sector.

Slower wages growth has helped to improve Australia's competitiveness, supporting the shift in growth.

The shift itself has also lowered wages growth, as higher paid mining jobs are being replaced by lower paid services jobs.

Low wages growth and inflation have also allowed the RBA to cut its cash rate, supporting the rebalancing of growth, and pushing the AUD lower, which has helped to improve local competitiveness.

Lower wages growth and inflation have helped to allow the economy to more smoothly absorb the impact of lower commodity prices.

We see inflation as likely to pick up when the rebalancing act is complete, which we forecast to be around mid-2017.

In our view, commodity prices have already passed the trough and mining investment should start to stabilise around mid-2017.

As a result, we see wages growth and underlying inflation stabilising soon and edging higher in 2017. It is for this reason that we do not expect the Australian cash rate to fall much further.

Our central case is for a 25bp cut in August, following the second quarter underlying CPI print (on 27 July) and for the RBA to hold its cash rate steady at 1.50% over subsequent quarters.

However, this view is conditioned on the Q2 underlying inflation print being below 0.5% q-o-q. If it is higher, the RBA may not cut.

Inflation Valiue Growth

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