For the first time in a year Australian annual CPI inflation looks set to tick higher ending the most recent phase of inflation not only coming in low each quarter but also coming in below low quarterly official and market inflation forecasts. Unlike the latest mild uptick in annual inflation that occurred between Q3 2017 (1.8% y-o-y) and Q2 2018 (2.1% y-o-y) the uptick that likely started in Q2 2019 (due for release 31st July) could last longer and be a little more pronounced for reasons developed below. Nevertheless, this next inflation uptick still looks a short-term cyclical event in a long-term dis-inflationary trend.
Looking towards the Q2 CPI report we forecast a 0.5% q-o-q increase taking annual inflation up to 1.5% y-o-y from 1.3% in Q1. Quarterly CPI increases have been 0.5% q-o-q or lower since Q4 2016. Factors helping to keep quarterly CPI readings low included low and sometimes falling wholesale prices; occasionally low petrol prices; declining house prices and rents; and some reductions in Government administered prices.
Some of these dis-inflationary factors are still in play, but one key one – petrol prices – turned sharply inflationary in Q2. Housing prices and rents also look less dis-inflationary in Q2 and are about to turn mildly inflationary in Q3 2019.
Taking petrol prices first, in Q1 2019 the Australian statistician reported that petrol prices fell between 7.8% q-o-q in Adelaide and 14.3% in Darwin contributing -0.27 percentage point (pp) reduction to the quarterly CPI. Petrol prices have lifted in Q2 almost as much as they fell in Q1 and conservatively will contribute +0.2pp to the Q2 CPI. If everything else in the Q2 CPI is unchanged the swing in contribution from petrol prices alone would generate a 0.47% q-o-q CPI.
Assuming no change in all other components of the CPI other than petrol is a tall order given that the CPI excluding petrol prices rose in Q1 by almost 0.3% q-o-q. It is reasonable to assume that the CPI ex petrol prices lifted somewhere between 0.1 to 0.2% in Q2, possibly even more. On this calculation, our 0.5% q-o-q Q2 CPI forecast is conservative.
The impact of petrol prices, however, is volatile quarter-to-quarter. While petrol prices may lift the CPI a lot in Q2 its contribution beyond is difficult to forecast. What can be said unfortunately is that the political situation around the Persian Gulf has deteriorated and looks set to remain tense for some time. Key oil supplies are likely to be subject to periods of disruption creating upward pressure on crude oil prices over the next year or two.
Another big-weighted component in the CPI that has been working to hold down CPI inflation over the past year has been housing (mostly house prices and rents). The total housing component of the CPI showed no change in Q1 2019 the same as the quarterly CPI change but was up 0.8% y-o-y less than the 1.3% CPI increase. Within the housing component housing rents rose less than 0.1% q-o-q in Q1 while purchase price of a home fell by 0.2%. Combined house prices and rents probably rose marginally in Q2 but are likely to show better gains in Q3 and beyond based on recent reports of housing activity.
Another factor working towards slightly higher CPI inflation include the indirect effects of the US/China trade war (higher international supply chain prices and a lower $A exchange rate than would otherwise be the case).
The factors leaning towards higher CPI inflation in the near-term – higher petrol prices; the turn upwards in housing prices; and higher import prices caused as an indirect consequence of the trade war – are probably sufficient to generate a little more pronounced and lengthier upward blip in annual inflation than has occurred in other blips in the longer-term dis-inflationary trend over the past decade or more. At this stage, however, it is still unlikely that annual inflation will push up much above 2% y-o-y over the next year or so.
The factors behind the long-term trend decline in inflation over the past 30 years are still in play. Slow wages growth is showing no signs of relenting. The prices of internationally produced goods although perhaps rising near-term are likely to resume sliding longer-term as production continues to move to low-cost producers. Demographic change, especially ageing populations, also militate towards higher savings over time and less strong demand helping to keep a cap on inflation as well.
The bottom line is that annual inflation is likely to be a little higher over the next year or two, but it is unlikely to stay higher.