WEEKEND ECONOMIST: Inflated opinions

The RBA left its official cash rate unchanged following this week's monthly Board meeting. The accompanying statement from Governor Stevens said that:

"While the inflation outlook remains concerning, the Board's assessment continues to be that demand growth will be moderate this year. The most recent flow of information has given additional support to that assessment. Inflation is likely to remain relatively high in the short term, and the CPI will be further boosted in coming quarters by the recent rises in global oil prices. Looking further ahead, inflation in both CPI and underlying terms should decline over time, provided demand continues to evolve as expected."

The June TD-MI inflation gauge points to a June quarter headline CPI of 1.3 per cent over the quarter and 4.3 per cent over the year, which is consistent with the RBA's May forecast of 4.25 per cent. It is also consistent with our monetary model, in which inflation is modelled as a deviation from a long-run equilibrium price level entirely determined by the stock of broad money. This points to a marginally firmer June quarter headline CPI outcome of 1.4 per cent quarter-on-quarter and 4.4 per cent year-on-year, so there is substantial agreement between our preferred bottom-up and top-down CPI inflation estimates.

We expect the March quarter weighted median to rise 1.2 per cent and the trimmed mean to rise 1.1 per cent, a slight moderation on the growth rates seen in the March quarter, but firmer than implied by the RBA's forecasts. It is worth recalling that the RBA favours these measures because they capture the persistent component of inflation that is most worrisome for monetary policy. There is little in the data that would give cause for a substantial near-term moderation in underlying inflation. The sharp downturn in activity forecast by the RBA by the end of the year could be expected to weigh on inflation outcomes from early next year, assuming that the RBA's growth forecasts are more than just wishful thinking.

This week's data once again gave little cause for optimism on the inflation outlook. May retail sales defied the doomsayers, although the pace of retail spending is still well down on last year. May building approvals were weaker than the market expected and fell to their lowest level since May 2007. Next week's May housing finance data has us expecting a fourth straight monthly decline of 2 per cent, pointing to continued weakness in approvals, compounding the national shortage of dwelling stock that is driving up rents and house prices.

The latest leading indicators of employment suggest that the June employment report next week will only just replace the jobs lost in May, with the unemployment rate seen steady at 4.3 per cent. Inflation has been accelerating ever since the unemployment rate started trending below 5.0 per cent, which gives a rough indication of the rise in joblessness that will be required to stabilise the inflation rate.

The RBA will have the benefit of a slate of June data when it meets in August. June quarter inflation may not be bad enough in its own right to demand a further rate rise in August. But activity data will have to show further moderation between now and then for the RBA to be confident that its inflation forecasts will be realised, without a further nudge from monetary policy.

Dr Stephen Kirchner is an independent financial market economist. His blog can be found at www.institutional-economics.com