• Alexander Funds Management

Inflation Uptick

For the first time in a year Australian annual CPI inflation looks set to tick higher ending the most recent phase of lower quarterly inflation for official and market 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 started in Q2 2019 (due for release 31st July) is likely to last longer and be slightly more pronounced. Nevertheless, this next inflation uptick still looks a short-term cyclical event in a long-term disinflationary trend.


Looking towards the Q2 CPI report we forecast a 0.5% q-o-q increase. This will take 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. Contributing factors for the low CPI readings 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 disinflationary factors are still of relevance, but a key factor would be petrol prices which turned sharply inflationary in Q2. Housing prices and rents also look less disinflationary in Q2 and are going 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 a -0.27 percentage point (pp) reduction to quarterly CPI. Petrol prices have lifted in Q2 almost as much as they fell in Q1. Conservatively it will contribute +0.2pp to the Q2 CPI. With all else equal, the swing in contribution from petrol prices alone would generate a 0.47% q-o-q CPI for Q2.


Assuming no change in all other components of the CPI other than 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 is certain however, is that the political situation around the Persian Gulf has deteriorated and looks 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 held down CPI inflation over the past year has been housing (mostly house prices and rents). The total housing component of CPI showed no change in Q1 2019, 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 prices of homes fell by 0.2%. Combined house prices and rents may have risen marginally in Q2, but these are likely to show better gains in subsequent quarters based on recent housing activity reports.


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).


Factors leaning towards higher CPI inflation in the near-term are higher petrol prices; the turn upwards in housing prices; and higher import prices caused as an indirect consequence of the trade war. These are probably sufficient to generate more pronounced and lengthier upward blips in annual inflation than other blips in the longer-term disinflationary trends over the past decade or more. At present, however, it is unlikely that annual inflation will push up much higher than 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 change. Despite short term increases in prices of internationally produced goods, these are still likely to resume sliding in the longer-term as production continues to move to low-cost producers. Demographic change, especially ageing populations, also militate towards higher savings over time. Slowing demand is also helping to keep a cap on inflation.


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.

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