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Inflation was surprisingly high in Q4 2013 and allowing that Q3 was surprisingly high too, headline CPI inflation was much higher than expected throughout the second half of 2013 annualising at 4.0%. The Reserve Bank (RBA) may not worry too much about the spike in inflation if it can be reasonably explained as being a temporary phenomenon. One reason why this may be the case is that the sub-trend economic growth, with weak employment growth and sub 3% annual wages growth would seem to imply little persistent inflation pressure. Yet, even with a number of special factors in play, weak economic growth should have helped to keep inflation down in the second half of 2013, but it did not. Before the release of the Q4 CPI, our view was that inflation was a slow-burn affair and would not start to become a concern until late 2014. As a result, we thought the RBA would highlight the building inflation risk in its forecasts around mid-2014 ahead of starting to lift the cash rate from August, after the Q2 CPI release.

We have not changed our cash rate view just yet (25bp cash rate hikes in August, September and November taking the cash rate to 3.25% by the end of the year), but we recognise that the risk is that the timings of these cash rate hikes could come forward three months if the Q1 CPI due in late April presents a third consecutive upside surprise. It is possible that the early May RBA board meeting could decide to hike the cash rate 25bp.

Much will depend upon the Q1 2014 CPI. The story behind the upside surprises in Q3 2013 (headline CPI up 1.2% quarter-on-quarter against market expectation of 0.8%) and Q4 (0.8% against market expectations of 0.5%) largely related to one-offs. In Q3 the big price increases were for council property rates, 7.9% quarter-on-quarter; petrol, 7.6%; water and sewerage, 9.9%; electricity, 4.4%; and domestic holiday travel, 3.5%. In Q4, weather played havoc with food prices with fresh vegetables up 7.1% and fruit prices up 8.1%. Holiday travel prices again rose strongly up another 6.9%. One theme running through the CPI in both Q3 and Q4 was that prices for services and charges in the government sector were escalating above 4% annual pace against less than 2% in the private sector.

The Q1 CPI often sees beginning of calendar year price increases in education and health. Apart from these two areas prices in the housing component of the CPI appear to be lifting early in 2014 and petrol prices are starting the quarter higher than in Q4 2013. Also, the Australian dollar has been depreciating since mid-2013 and the first effects of the depreciation lifting some domestic prices may show in Q1. In short, there are already a number of pricing pressure points in Q1 and the likelihood of a CPI reading capable of taking some pressure off the RBA, say around 0.5% with underlying – trimmed mean and weighted median both 0.9% in Q4 – around 0.5% as well, seems quite low.

Just how the RBA is changing its inflation outlook should become evident over the next 10 days or so. The first RBA board meeting of 2014 is on Tuesday 4th February. No cash rate change is expected, but the wording of the accompanying statement will probably acknowledge that inflation is running higher than the RBA forecast previously. The RBA will provide its latest inflation forecasts in its quarterly Monetary Policy Statement due on Friday 7th February. Most likely the mild policy easing bias language of the previous Monetary Policy Statement will disappear in favour of strictly neutral language relating to the rate outlook and a first sign that the next interest rate move is upwards.