SCOREBOARD: Inflation puzzle

The market is pricing in a big fall for headline CPI but it seems the RBA has shifted its rates goal posts.

Australian CPI this Tuesday (1130 AEDT) is going to be quite interesting. The consensus market forecast is that headline prices rose by 0.7 per cent, which if we get that, should see the annual rate of inflation fall to about 2.3 per cent from 3.1 per cent in fourth quarter. This sounds like a big drop – and it is – but remember, this largely reflects the impact of the floods dropping out. As for the average of the statistical cores (weighted median and trim) they expected to rise only a slightly more modest 0.6 per cent for the quarter which should see annual core rates dip to 2.4 per cent from 2.6 per cent (assuming no revisions).

Overall, these forecasts are quite reasonable and I wouldn’t expect anything too different. Inflation is certainly looking much more modest than what it was mid-2011, but as regular readers know I suspect there are some temporary factors at play here, largely to do with last year’s US and European hysteria, and we also can’t forget the ABS changes which have had the effect of dampening inflation outcomes. Trying to get a sense of what underlying inflation is doing, what the true momentum is, has been extremely difficult in this environment. Hopefully it has declined, really declined, but I’m not convinced yet.

Now in terms of inflation drivers this quarter we can expect some seasonal gains in health and education, a few other gains in the utilities space. Gains here will be seasonally adjusted out in calculating the cores – which of course has the effect of artificially lowering core inflation outcomes. Otherwise, rents should provide a sizeable lift in CPI given our builders have decided it’s not worth building anything or can’t raise the funds to do it. Who knows. Either way it lifts the cost of housing more generally.

On the flipside we know that fruit and vegetable production has been sizeable and we should see another solid fall across these components. Then of course the Australian dollar is providing decent inflation relief and you can see this most clearly through the tradeable goods index. Prices here fell 1.2 per cent in the fourth quarter and over the year are 1.8 per cent lower. Nevertheless, outside of the currency impact we’re not seeing much in the way of moderating inflation. Non-tradeable inflation for instance is running at an annual pace of almost 4 per cent. Until this component changes, inflation eases, I’m not convinced that the decline in overall inflation is anything other than temporary, especially given the introduction of the carbon tax in a couple of months. But I’ll go into more details at a later date.

Now of course for the RBA I don’t think it really matters that much. As I mentioned last week, the RBA board has very visibly shifted the goal posts in a fairly grotesque display, in order to lower the bar for a May rate cut. A cut is pretty much done then I think, unless core CPI is very high, 0.8 per cent and above, although some are even arguing that a 0.8 per cent wouldn’t be too high, which is an extraordinary thing to say. But it goes to show you how desperate some quarters are for a rate cut – that they will dismiss economic data such as strong demand, the recent surge in jobs and hours, low unemployment and now a lift in the CPI (if we get that). Bad policy for sure, but the board has been stacked with people who in my opinion are biased and shouldn’t be there. Moreover, the political interjections we’ve seen have been breathtaking – from unions, government and some business people. All of this points to only one thing – bad policy decisions. "We want rate cuts no matter what”, they are saying. It all comes down to leadership and unfortunately in Australia today, there is a huge vacuum here.

Outside of Australia the US has a lot of data out, but much of the focus will probably be on the FOMC decision. Again it’s difficult to know what Ben Bernanke will do. I don’t think they will ease (print more money) at this meeting but I do think, at this stage still, that QE3 is still coming. For this meeting they’ll probably focus on some of the indicators that have slowed, especially the jobs figures and so the statement will likely be a touch more dovish in that regard, notwithstanding the acceleration in economic activity more generally. Don’t forget the Fed also releases economic forecasts and Fed fund projections.

I wouldn’t expect too much here, maybe a modest upgrade to growth but nothing major and I expect some of the rhetoric to offset any upgrades. Note though that Bernanke has clearly been wrong on the US economy – inflation is faster, the unemployment rate lower and growth stronger. Yet Bernanke and others ignore this inconvenient truth to the extent that we have seen the Fed continually print, even in the face of rapidly improving data. That’s why I’m not convinced that improving data now will stay their hand. Officially the slogan is that the Fed won’t print again unless momentum slows, although some have said that a failure for it to pick up from here would be sufficient. I have noted before how the justification for QE has changed – from the fear of deflation and double dips to just growth (which is above trend at the moment) isn’t quick enough. The Fed too have been changing the goal posts and I suspect they will continue to do so. Seems to be the way for central banks these days.

As to the data that’s worth watching there is a bit. Not much tonight, but on Tuesday we see consumer confidence (Apr), Richmond Fed (April), New home sales (March). Then Wednesday we get Durable goods (March) the FOMC of course and Initial jobless claims and pending home sales on Thursday. Finally on Friday we see the first estimate of the first quarter US GDP. The market expects growth of around 2.5 per cent for the quarter after a 3 per cent gain in the fourth quarter. The final estimate of Michigan consumer confidence for April is also due.

Over in Europe, we have the EU foreign ministers meeting tonight, alongside the EC PMI’s for April. There are also quite a few speeches from ECB officials kicking off on tonight (Bundesbank head Jens Weidman for instance and ECB head Mario Draghi on Wednesday). Then watch out for German CPI on Thursday. Other data of interest includes UK (Wednesday) and South Korean GDP (Thursday), the RBNZ meeting (Thursday and no change expected) and Japanese industrial production (Friday). Don’t forget we see Australian producer prices today as well (1130 AEDT).

Adam Carr is a leading market economist. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.

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