The Australian fourth quarter 2016 inflation data was a little softer than expected. The headline consumer price index rose by 0.5% quarter on quarter (the consensus was expecting 0.7% qoq) and annual growth was 1.5%. Underlying inflation, which is the Reserve Bank of Australia’s preferred measure of price growth, rose by 0.4% qoq (the consensus +0.5% qoq) and annual growth lifted slightly to 1.6% (or 1.55% to be precise).
Both headline and underlying inflation remain below the RBA’s 2-3% inflation target band (see chart below), imparting a bias to cut interest rates again.
Across the categories, the most significant prices rises occurred in tobacco (+7.4%) because of the government’s lift to the tobacco excise, fuel (+6.7%) as oil prices rose and lifted petrol prices and domestic holiday travel and accommodation (+5.5%) which normally tends to lift at this time of the year. Offsetting this though were price falls in clothing, furnishing and household equipment, car prices and international holiday travel.
While a rebound in headline inflation was to be expected (at 1.5% year on year now it is up from 1% year on year in the June quarter) as global oil prices normalised, the continuing weakness in underlying inflation highlights that cost pressures and pricing power in the economy remain weak. Almost continuous sales are an example of this lack of pricing power.
Implications
Annual inflation at 1.5% in the December quarter is line with the RBA’s own forecasts, but record low wages growth and spare capacity in the economy (with GDP growth now running well below average) mean that underlying inflation is likely to take longer than the RBA is allowing to get back to its 2-3% inflation target band. We expect that continued weak inflationary pressures along with a downwards revision to the RBA’s growth forecasts following last September quarter’s contraction in GDP will force the RBA to cut the cash rate again by 0.25% taking it to 1.25%. A February rate cut looks unlikely at this stage – the labour market is holding up and the RBA may want to monitor the recent uptick in investor loan growth because of the risk to financial stability. But we think a rate cut is likely in May, following the next set of inflation data.