What inflation means for the RBA in May

Most economists predict today's CPI to fall below the RBA's target band, opening the door to a May rate cut, but the possibility of revisions to last year's data could throw a curveball.

With so much talk about today's ABS inflation data and the potential ramifications this will have for the Reserve Bank's rates decision at its May board meeting, I thought I would pull together my own 'cheat sheet'. 

In brief, this guide combines the March quarter core inflation numbers with the inflation measured over the preceding three quarters to give a March 2012 year-on-year result. The Reserve Bank has become increasingly wary of historical revisions to the ABS's underlying inflation data (known as the "trimmed mean" and "weighted median"), and it is likely to place significant emphasis on the broader results over the last six and 12 months. 

By way of background, the RBA has worked hard to prepare the public and financial markets for a cut in May subject to the outcome of the March price data. Predicting a cut if inflation prints low is easy. The much more difficult challenge was anticipating the RBA's decision to hold rates steady in February, March, and April, which caught some experts unawares. 

Of the 22 economists polled by Bloomberg (I have also added in economist Stephen Koukoulas), none are predicting an especially high core ("trimmed mean") inflation print: the maximum quarterly estimate is 0.7 per cent from Credit Suisse, JP Morgan, and Nomura (see the first chart below). At least seven economists are expecting a relatively low core inflation number of 0.5 per cent. Given the currency appreciation, declining import prices, weak producer prices and various surveys pointing to benign retail prices, it's possible that inflation is assessed to be even lower than 0.5 per cent.

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Of course, the flipside of this coin would be an upside surprise. Nobody is projecting inflation breaching the top of the RBA's target 2 per cent to 3 per cent per annum band in the March quarter. A positive 'surprise' would be anything greater than 0.7 per cent.

It is also interesting to observe that the economists' year-on-year expectations are all universally anodyne. Only two houses (Credit Suisse and Nomura) are predicting that the 12 monthly result will hit the mid-point of the RBA's target band at 2.5 per cent, which is where the RBA believes inflation currently stands.

Every other forecaster has a year-on-year number below the mid-point of the target band, which opens the door to a Reserve Bank rate cut. A curve ball here is substantial revisions to the third- and fourth-quarter data from last year, which could mean that even with a soft first-quarter number year-on-year inflation could stay at or above the mid-point of the RBA's band.

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The question is then what all of this means for what the Reserve (or, more precisely, its board) decides to do in May. I've taken the RBA's latest estimates of core inflation in Australia over 2011 and combined these with a range of hypothetical outcomes in March. I've then offered up my own opinion of what the bank might do – subject to global events, revisions to past data, and changes to bank lending rates – in the far right-hand-side column.

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Christopher Joye is a leading financial economist and a director of Yellow Brick Road Funds Management and Rismark. The above article is not investment advice.

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