The Australian Q4 2016 CPI report is due out on Wednesday this week and the range of analysts’ forecasts is much wider than usual ranging +0.3% q-o-q to +1.1% q-o-q and +1.2% y-o-y to +2.0% y-o-y. The wide range of forecasts is hardly surprising given that the previous Q3 CPI reading at +0.7% q-o-q was well above consensus forecast of +0.3% q-o-q and the reasons for the miss. Analysts underestimated substantial increases in fresh fruit and vegetable prices as well as a big quarterly increase in the price of furniture and household equipment. The Q3 CPI report proved that even what should be the most predictable of the ABS data releases can sometimes produce unexpected results.
A one-quarter higher-than-expected CPI result does not necessarily mean that inflation is starting to rise or become a problem. In the context of the Q3 CPI report, there was if anything still plenty of evidence that inflation was too low from the RBA’s point of view. The annual change in the CPI at +1.3% y-o-y was still sitting well below the bottom of the RBA’s 2% to 3% target band. Also the changes in the two main underlying inflation readings, the trimmed mean, +0.4% q-o-q, +1.7% y-o-y, and the weighted median, +0.3% q-o-q, +1.3% y-o-y were low and came in in line with analysts’ low inflation forecasts.
In the wake of the Q3 CPI report the RBA also had no reason to change its view that annual inflation would remain below target over the coming 18 months or so. Powerful influences holding down inflation such as record low annual wages growth, only 1.9% y-o-y in Q4 2016 and the relatively firm Australian dollar exchange rate and low producer prices, up only +0.3% q-o-q, +0.5% y-o-y in Q3, all implied little pressure for inflation to rise consistently.
Even with a wide range of views about the Q4 2016 CPI it is unlikely that the result when it comes on Wednesday, even if it is near the top end of the range of analysts’ forecasts, will alter the RBA’s view that inflation is well contained for the time being. Nevertheless it is probably fair to say that the RBA is becoming a little warier that annual inflation, while staying low through 2017, could rise potentially in 2018.
The reasons for being a little warier about inflation in the medium-term mostly derive from a mild lift in inflation internationally and the possibility that various potential developments internationally could add to upward pressure on inflation.
Inflation in the US has accelerated just above +2% y-o-y and in Europe has lifted to +1.1%. Two factors that may lift inflation further, are rising energy prices (OPEC is looking a more effective agent for containing global oil output) and rapidly rising factory-gate prices in China where annual change in producer prices has accelerated from -5.9% y-o-y at the beginning of 2016 to +5.5% y-o-y at the end of the year. These factors over time are likely to push inflation a little higher (mostly on a headline rather than underlying basis) and not just in the US, Europe and Asia, but extending to Australia too.
Another factor that has the potential to lift inflation and possibly quite substantially are the economic plans, such that we know them, of President Trump. Doubling US economic growth is a laudable objective mostly through a burst of government spending plus tax cuts, but coming at a time where the US economy is showing signs of accelerating wages growth and is clearly approaching capacity, the additional boost to growth would come with increasing inflation.
Another inflation-priming part of President Trump’s plan is the heralded move to greater protection for US industry. Limiting free international trade and increasing import tariffs will lift prices. The actions that other countries take to counter the US moves are also likely to lift prices in other countries too, including Australia.
There is an area of significant uncertainty about what potential changes to US economic policies may mean because there is great uncertainty about what will or will not be enacted. Having said that, if what has been proposed by President Trump in outline is mostly enacted, inflation internationally and Australia could increase significantly in 2018 and 2019.
The impact of the possible shift in inflation outlook means that the RBA can no longer be so confident that local factors will hold inflation down. There is a new and difficult to assess potential inflationary pressure point developing from international forces. The RBA is likely to be reluctant to push the cash rate down any further, even if the CPI result this week is surprisingly low. The RBA is likely to be watchful of pressure on inflation building from international changes. For the next few months at least the RBA is likely to stay on cash rate pause but down the track the next rate move when it comes is likely to be a hike.