CPI Pressures Rise, But Rates On Hold

In the minutes of the April 1 meeting of the Reserve Bank the following was said about inflation and the March quarter’s Consumer Price Index.

“Members were informed that the CPI data for the March quarter, to be released towards the end of April, were likely to show inflation of around 4 per cent on a year-ended basis in the March quarter. A large quarterly increase was expected partly because of recent rises in retail petrol prices.

“Underlying inflation was also expected to rise in year-ended terms in the March quarter, before declining over time.

“The staff’s inflation forecast through to 2010 would be revised after the release of the March quarter CPI, but the preliminary assessment, based on current policy settings, was that inflation on both a CPI and underlying basis would fall by a little more than earlier thought over the next two to three years.

“This was premised on demand growth slowing sufficiently to reduce capacity pressures. Members recognised that a considerable degree of uncertainty continued to surround the outlook for both demand and inflation.”

On May 6 the Reserve Bank meets again and won’t touch interest rates because it was expecting a high number, despite attempts by some nervous nellies (or those sniffing a trading opportunity) to spark a headline of “rate rise looms.”

But the question now is: for how long can the RBA hold to this line in the face of some quite sharp additional price pressures that did emerge in the domestic economy in the March quarter.

The March retail trade figures, out late next week, loom as a major barometer of the way the RBA will go. If they show a rise in sales after two flat months, we could see a 0.25% rate increase the following Tuesday. It is as finely balanced as that, according to some analysts.

August looms as possibly the next time the bank can make a judgment based on the June quarter’s CPI.

The March quarter CPI in all its forms - headline, stripping out the impact of housing and financial services and insurance, and the RBA’s two main measures, the Trimmed Mean and Weighted Median- was high.

While it was expected, the sharp rise in the prices of non-tradables which are set in the domestic economy shows the extent of price pressures in the economy and confronting the Reserve Bank.

Yes, rising oil prices are a major concern (and responsible for much of the sharp jump in the cost of tradeables in the quarter), but non-tradeables rose 1.7% in the quarter for an annual rate of 5.0% (4.2% in the year to December).

The tradeables component rose 0.8% for an annual rate of 3.3% (1.4% in the year to December), thanks mainly to the surging world price for oil and its impact on petrol costs here.

The real worry is the way the US dollar keeps dipping lower, driving up commodity prices faster than the rising Australian dollar (over 95 USc yesterday), can moderate the increases.

With oil sniffing the $US120 a barrel mark, copper and grains again firming, the price outlook can’t be viewed with any great confidence, despite the slide in retail demand and housing in the past few months.

The headline CPI rose 1.3% in the March quarter, for a rise of 4.2% over the year. That compared to a rise of 0.9% in the December quarter and 3.0% for all of 2007. Prices actually rose at a much faster rate in the second half of 2007 after a slower than expected rise in the January and March quarters.

The low January quarter has now dropped out of the comparison, which pushed the rate higher. The inflation rate will continue at well above 3% for this reason for the rest of this year, but it shouldn’t mean a rate rise.

But the chances of a rate cut have receded, especially with oil prices kicking higher and closing on $US120 a barrel overnight.

Excluding housing, financial services and insurance, the increase was 1.1% and 3.5%. (This measure jumped from the 0.7% quarterly and 2.2% annual rate in the December quarter, showing the extent of the price pressures apart from those introduced by the rising cost of financial services from the impact of higher interest rates).

The Australian Bureau of Statistics said the most significant contributors to the increase this quarter were automotive fuel (+5.4%), pharmaceuticals (+13.1%), house purchase (+1.7%), electricity (+6.0%), rents (+2.0%) and other financial services (+2.0%), while the most significant offsetting decreases were for furniture (-3.6%), audio, visual and computing equipment (-5.8%), domestic holiday travel and accommodation (-1.4%) and accessories (-5.3%).

The items to fall are all minor in the schemes of everyday life.

Over the year to March transport rose 6.8%, food 5.7%, housing 5.7% and health was up 4.5% (and 4% in the quarter alone). The cost of education rose 5.21% in the quarter and by more than 4% in the year.

The Reserve Bank’s version (Trimmed Mean and Weighted Median) rose 4.1% and 4.4% over the year and 1.2% and 1.3% in the quarter. Both showed a sharp rise from the December quarter.

The CPI numbers were expected on both a headline and a so-called core basis: the RBA and Governor Glenn Stevens had spent the last month softening us up for a big number and explaining the RBA’s reaction in advance.

But the big imponderables are oil prices and the US dollar’s continued slide, especially against the euro. Oil hit US119.90 a barrel in New York overnight as the current futures contract expired and the US dollar hit a new low against the euro, breaching $US1.60 for the first time (it hit $US1.6019) before easing back under that level.

The ABS said the non-tradables component of the CPI rose 1.7% in the March quarter. (Prices for the goods and services in this component are largely determined by domestic price pressures.)

The ABS says the non-tradables component represents approximately 58% of the CPI. Within non-tradables, the services component rose 1.4%, mainly due to rents, other financial services, secondary education fees, deposit and loan facilities, tertiary education fees, hospital and medical services and preschool and primary education fees.

The only significant offset was provided by domestic holiday travel and accommodation. The non-tradable goods component rose 2.4% mainly due to increases for house purchase and electricity.

The tradables component of the All groups CPI rose 0.8%. Prices for the goods and services in this component are largely determined on the world market.

The tradables component represents approximately 42% of the weight of the CPI. The rise in the tradables component was driven by increases in automotive fuel and pharmaceuticals. The most significant offsetting falls were in furniture and audio, visual and computing equipment.

Through the year to March quarter 2008, non-tradables rose 5.0% and tradables rose 3.3%.

This compares with rises of 4.2% and 1.4%, respectively, for these components through the year to December quarter 2007.

The main drivers in non-tradables through the year were house purchase, rents, deposit and loan facilities, other financial services and electricity.

Automotive fuel was the main contributor to the rise in tradables, with less significant contributions from overseas holiday travel and accommodation, vegetables and tobacco.

What we need to get rates on hold or tending lower is more and much clearer signs of a slowdown and a rise in unemployment: or more problems emerging among banks and financial groups.

No rate rise yet, but the outlook is much more mixed than it was a week ago.

“Rate cut looms” is now a headline we won’t see until well into 2009, unless there is an almighty slowing in economic activity, very quickly. And that doesn’t look like happening soon.

The March retail trade figures are out on friday, May 2. If they show a rise in activity after the flat months of January and February, then the chances of a rate rise the following Tuesday will rise sharply.

This Information is provided to you by the Australasian Investment Review (AIR).
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