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The Approaching Inflation Peak

Australia’s annual CPI inflation rate is likely to peak for the current upswing with the Q1 2022 CPI report to be released on Wednesday 27th April. Annual headline CPI inflation will be around 4.5% y-o-y, comparatively low by international comparison, but well above the RBA’s 2-3% target range. Underlying annual inflation using the trimmed mean and weighted median measures are likely to push up to around 3.2% y-o-y in the Q1 report but may not peak until the Q2 or Q3 2022 reports.

The sharp rise in petrol prices in Q1 and even bigger fall so far in Q2 is the reason why annual CPI inflation almost certainly peaked in Q1. Going back to Q4 2021 transport costs (mostly petrol costs) rose by 2.8% q-o-q or 12.5% y-o-y providing the biggest contribution to the Q4 CPI, up 1.3% q-o-q, 3.5% y-o-y. In Q1 2022, transport costs will rise more than 5% q-o-q contributing at least 0.5 percentage points to the quarterly CPI rise.

On our calculation, the Q1 CPI rise is around 1.7% q-o-q which would lift the annual CPI inflation rate from 3.5% y-o-y in Q4 2021 to 4.5% in Q1 2022. What the outsized lift in petrol prices via the transport cost component contributes to the quarterly CPI rise in Q1, it detracts and more in Q2. Outside of petrol price change, other CPI components combined are tracking around 1.0% q-o-q. Add back in the sharp fall in petrol prices in Q2 and the CPI could come in at 0.4% q-o-q or less in Q2, well below the 0.8% q-o-q CPI rise in Q2 2021 and causing on base effect the annual CPI increase to come down to around 4.0% y-o-y.

The peak in underlying annual inflation will occur beyond Q2 2022. The quarterly movements in the trimmed mean and weighted median measures are seasonally adjusted and are based on the prices of goods and services removing extreme high and low item price movements from the calculation. The underlying inflation measures provide a truer picture of lasting price changes. They are less volatile than the headline CPI. In Q4 2021 the trimmed mean and weighted median had lifted into 0.9% to 1.0% q-o-q range and we expect them both to be in that range again or a touch higher in Q1 2022.

In the Q1 readings due next week trimmed mean and weighted median inflation readings of 1.0% q-o-q (they were 0.4% and 0.3% respectively in Q1 2021) will see annual underlying inflation lift to 3.2% y-o-y from 2.6% in Q4 2021. Underlying inflation may edge down slightly to 0.9% q-o-q in Q2 (it was 0.5% in Q2 2021) that would see annual underlying annual inflation lift on our forecast from 3.2% y-o-y in Q1 to 3.6% y-o-y in Q2, but that still may not be the peak.

In Q3 2021, underlying inflation rose 0.7% q-o-q. It is a fair chance that underlying inflation in Q3 2022 will come in around 0.9% q-o-q which would lift annual underlying inflation to 3.8% y-o-y.

Looking beyond the peaks in annual inflation in Q1 2022 for the headline CPI and Q3 or so 2022 for the underlying inflation rate what are reasonable estimates for how much annual inflation may moderate late 2022 and in 2023? There are likely to be some large base effects from some items exhibiting unusually big price increases recently and currently – petrol prices, supply chain affected prices of manufactured goods, food prices affected by war and floods.

Set against these items, other CPI components are likely to be exhibiting continuing if not increasing inflationary pressure. The housing component of the CPI was up 1.8% q-o-q, 4.0% y-o-y in Q4 2021 and is likely to inflate faster through this year and in 2023 under pressure from faster rising rents and home mortgage payments as interest rates rise. The recreation and culture component of the CPI was up 1.5% q-o-q and 2.1% y-o-y in Q4 2021 but is likely to rise faster through 2022 with the costs of holidaying and many other recreational activities enjoying a surge in demand but meeting constrained supply.

All told allowing for the powerful lower inflation base effects in play late this year and early in 2023 plus those areas where inflation is still building and with still relatively slow rise in wages, quarterly headline CPI and underlying inflation readings settle at an average 0.7% q-o-q from Q4 2022 through 2023. That means our forecast peak CPI inflation rate of 4.5% y-o-y in Q1 2022 reduces to around 2.8% y-o-y in Q1 2023 before lifting to 3.1% y-o-y in Q2 2023.

Underlying annual inflation after peaking at 3.8% y-o-y in Q3 2021, settles back to around 3.0% y-o-y by late 2023.

Our inflation forecasts come with the provisos that there are no further big upside inflation shocks from much higher food and energy prices or the like and that Australian wage growth does not accelerate rapidly.

Our quite conservative inflation forecasts indicate the RBA will get evidence that inflation is consistently within if not above 2-3% target band with the Q1 CPI release next week. That will be the trigger for a cash rate hike, although the RBA may still want to see the Q1 wage price index out in mid-May before delivering a rate hike.

Our inflation forecasts also indicate that the RBA has a smaller inflation problem to tackle than its peer central banks in New Zealand, the USA, Canada, Britain and Europe all experiencing peak inflation well above 5% y-o-y. Australian bond yields have risen more than bond yields overseas and rate hikes are expected to be more and to occur more quickly than in the US over the next year or so. If Australian inflation pans out as we expect at some point Australian bond yields and expectations of rate hikes will moderate relative to bond yields and rate hike expectations overseas. We expect that the Australian cash rate will finish 2022 at 1.25% and 2023 at 2.00%.