CPI Preview Dec 2011[1]

8/3/2019 CPI Preview Dec 2011[1]

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23 January 2012

CPI Preview - December Quarter 2011

The December quarter CPI outcome will be vital to the RBA February interest ratemeeting. The RBA has become increasingly cautious over recent months having beenwrong footed by a serious resurgence in international financial market instability

emanating from European sovereign debt concerns. A weak underlying CPI result (below0.7%), coming on the heels of declining asset prices, soft credit demand and an apparentrise in discouraged workers, would likely complete the case for a rate cut.

On the basis of our models, which reflect spare capacity, labour cost inflation, productivitygrowth, currency movements, import prices and fuel costs, we expect a very low coreinflation reading of 0.5% (2.4% annual) in the December quarter. The November NABbusiness survey also pointed to continuing weakness in retail price inflation indeed itpoints to downside risk to the Q4 forecast. We would not expect core inflation (ex carbontax) to enter the upper half of the RBA target range until late 2012.

Consequently, there is likely to be a stronger case for more accommodative monetarypolicy following the CPI release. The economy is clearly struggling to adjust to thepressures of the mining boom, becoming increasingly distorted by the strength of the AUDand the outlook for minerals and infrastructure investment. Beyond February, the RBA

may face the issue of whether the lagged impacts of three successive rate cuts willcoincide with a mining sector induced re-kindling of the domestic economy in late 2012.

Headline CPI inflation may be even weaker than the underlying rate in the Decemberquarter because of declining fruit and vegetable prices. This is less relevant to the RBAdeliberations but it will mean some easing of cost of living pressures.

We will publish revised international and domestic forecasts with the December 2011 NABbusiness survey results on 31 January.

CPI Forecasts

Jun-11 Sep-11 Dec-11 (f) 2010 2011 (f) 2012 (f) 2013 (f)

Headline CPI 0.9 0.6 0.2 2.7 3.3 3.2 2.8

Core CPI (ex carbon tax)* 0.8 0.3 0.5 2.4 2.4 2.6 2.7

Quarterly % change Year to December quarter % change

* Core CPI is the average of trimmed m ean and weighted median CPI

What do the models say about core inflation?

NABs models of underlying or core inflation are based on such factors as the size of the outputgap, labour costs growth, productivity growth, currency movements, fuel prices and errorcorrection mechanisms. In addition to our own models, we also monitor a model based onpublished RBA research, which includes a model based principally on unemployment and importprices. As can be seen in the following chart, the fit of NABs forecasts to the average of ourmodels and the RBAs is reasonably robust more so since the ABS revised the history ofunderlying CPI although it did struggle to predict the very subdued CPI outcome in theSeptember quarter. Nonetheless, the models suggest that underlying inflation will remain

reasonably contained both in Q4 2011 and Q1 2012, predicting underlying inflation of 0.6% in theDecember quarter, with a fairly gradual rise in inflation expected thereafter. Given our expectationof a fairly soft inflation reading in the December quarter, we believe there is scope for the RBA tolower the cash rate by an additional 25 bp in February, with the potential for another cut in thefirst half of this year if domestic activity and inflation remains subdued.


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Core CPI vs. modelsQuarterly

0.0

0.2

0.4

0.6

0.8

1.0

1.2

2005 2007 2009 2011 2013

%

0.0

0.2

0.4

0.6

0.8

1.0

1.2

%

Source: ABS; RBA

Forecasts

Average of models

Actual

More Detailed Comments

The RBA targets an underlying rate of inflation, which is measured using the trimmed meanand the weighted median inflation rates. Both of these series are used by the RBA to assess theunderlying rate of inflation in the economy. Trimmed mean inflation is defined as the average rateof inflation after trimming away 15% of price changes at both ends of the distribution, whileweighted median inflation is the rate of change in the item in the middle of the distribution. Takentogether, these underlying rates of inflation were surprisingly low in the September quarter, withthe average underlying quarterly rate just 0.3%. Consistent with our estimate of the NABQuarterly Survey retail price index which has historically had a reasonably strong relationshipwith core inflation underlying inflation may be expected to remain quite soft in the Decemberquarter.

Core CPI & NAB retail pricesQuarterly percentage change

-0.2

0.0

0.2

0.4

0.6

0.8

2002 2004 2006 2008 2010 2012

%

0.2

0.4

0.6

0.8

1.0

1.2

%

NAB retail prices (LHS)

Core CPI (RHS)

Other specific factors impacting the December headline CPI result

Housing costs are forecast to have stabilised in the December quarter (note that only rentsand new project house costs are relevant to the CPI). Housing price data continued toweaken in the final months of 2011, while the NAB Residential Property Survey provided asubdued outlook for rents in the December quarter. Nonetheless, there may be furtherupwards pressure on utility prices, which rose solidly in the September quarter, although themagnitude of any price movements is expected to be small, so they are not expected to be

trimmed out of underlying measures of CPI. The softening in employment growth over the December quarter and the gradual rise in the

rate of unemployment over 2011 are expected to have helped limit the formation of wagepressures in the labour market. While NAB business surveys show that the availability of

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suitable labour remains a significant constraint on firms, consistent with the deterioration inemployment conditions, labour costs growth has eased over recent months.

Fruit & vegetable price inflation was fairly soft in the September quarter, following sharpincreases in the previous two quarters, which reflected supply side shocks to food agricultureresulting from the floods at the beginning of 2011. Wholesale fruit and vegetable price datashow that prices generally softened in the December quarter, with fairly solid falls recordedfor some varieties although there were a handful of large offsetting price increases. Taken

together, we estimate that a fall in fruit & vegetables could fall by around 10% in the quarterunderpinning a further softening in the headline CPI.

Dec-11

Jun-11 Sep-11 Dec-11 Qtr % change

Apple 100 100 100 0.0

Banana 100 66 8 -87.5

Lemon 100 91 118 30.0

Orange 100 100 125 25.0

Pear 100 100 80 -20.0

Raspberry 100 97 49 -49.7

Strawberry 100 47 44 -4.8

Watermelon 100 226 45 -80.0Source: Datafresh

Fruit prices

Index (June qtr 2011 = 100)

Dec-11

Jun-11 Sep-11 Dec-11 Qtr % change

Broccoli 100 43 62 44.4

Carrot 100 106 96 -9.8

Cauliflower 100 61 75 22.7

Cucumber 100 32 25 -22.5

Egg plant 100 88 53 -40.0

Herbs 100 85 109 28.3

Lettuce 100 100 42 -57.9Mushroom 100 100 100 0.0

Onion 100 126 79 -36.7

Potato 100 96 95 -0.7

Spinach 100 100 100 0.0

Sweet corn 100 32 37 15.8

Tomato 100 51 32 -37.4

Vegetable prices

Index (June qtr 2011 = 100)

Source: Datafresh

ABS data show that consumer import prices grew by 1.7% in the December quarter,suggesting that the depreciation of the Australian dollar relative to other major currenciesover the past year or so may have begun to flow through to higher prices. However, NABsQuarterly Business Survey points to a slight softening in overall purchase costs growth in the

December quarter; suggesting that the pricing of domestic purchase goods may have eased. Transportation costs are likely to have increased a little in the December quarter, reflecting

a 1.0% increase in fuel prices at the pump, despite a 5.6% increase in the price of importedfuels and lubricants (imported fuel prices tent to be more volatile than pump prices).

Assessment

December quarter inflation is expected to have been fairly soft, reflecting continued softness ineconomic data and the weakness in international financial and economic environments, which isweighing on confidence domestically. While the RBA has already provided some stimulus tointerest rate sensitive sectors of the economy via two rate cuts at the end of last year, the softoutlook for near-term inflation suggests there may be further scope for the RBA to ease policy.Given that credit growth has been subdued, asset prices have declined and labour marketconditions have softened over recent months, the risk that inflation will rise above the RBAs 2-

3% target band over the medium term remains small. In fact, risks to inflation appear moreskewed to the downside at present.

While the state of the global economy is expected to remain the focus of the global markets over2012, we expect the Australian economy will remain reasonably robust, as the mining investment

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boom strengthens and a boost to domestic demand provides support to the labour market. Ofcourse, financial market risks faced by the European banking system pose some downside risk tothe Australian economy and inflation, and it is this which supports our expectation that furtherpolicy easing will be necessary to support demand in the near term.

For more information contact:

Alan Oster

Group Chief Economist03 8634 2927(Mobile 0414 444 652)

Rob Henderson

Chief Economist Markets Australia02 9237 1836

Rob Brooker

Head of AustralianEconomics & Commodities03 8634 1663

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Macroeconomic, Industry & Markets ResearchAustralia

Alan Oster Group Chief Economist +(61 3) 8634 2927

Jacqui Brand Personal Assistant +(61 3) 8634 2181

Rob Brooker Head of Australian Economics & Commodities +(61 3) 8634 1663

Alexandra Knight Economist Australia +(61 3) 9208 8035Vacant Economist Australia & Commodities +(61 3) 8634 8602

Michael Creed Economist Agribusiness +(61 3) 8634 3470

Dean Pearson Head of Industry Analysis +(61 3) 8634 2331

Gerard Burg Economist Industry Analysis +(61 3) 8634 2788

Robert De Iure Economist Property +(61 3) 8634 4611

Brien McDonald Economist Industry Analysis & Risk Metrics +(61 3) 8634 3837

Tom Taylor Head of International Economics +(61 3) 8634 1883

John Sharma Economist Sovereign Risk +(61 3) 8634 4514

Tony Kelly Economist International +(61 3) 9208 5049

James Glenn Economist Asia +(61 3) 9208 8129

Global Markets Research - Wholesale Banking

Peter Jolly Head of Markets Research +(61 2) 9237 1406

Robert Henderson Chief Economist Markets - Australia +(61 2) 9237 1836

Spiros Papadopoulos Senior Economist Markets +(61 3) 8641 0978

David de Garis Senior Economist Markets +(61 3) 8641 3045

New ZealandTony Alexander Chief Economist BNZ +(64 4)474 6744Stephen Toplis Head of Research, NZ +(64 4) 474 6905Craig Ebert Senior Economist, NZ +(64 4) 474 6799Doug Steel Markets Economist, NZ +(64 4) 474 6923

London

Tom Vosa Head of Market Economics - Europe +(44 20) 7710 1573Vacant Market Economist Europe +(44 20) 7710 2910

Foreign Exchange

Fixed Interest/Derivatives

Sydney +800 9295 1100 +(61 2) 9295 1166

Melbourne +800 842 3301 +(61 3) 9277 3321

Wellington +800 64 642 222 +800 64 644 464

London +800 747 4615 +(44 20) 7796 4761

New York +1 800 125 602 +1877 377 5480

Singapore +(65) 338 0019 +(65) 338 1789

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CPI Preview Dec 2011[1]