MNI ANALYSIS: CPI Challenges RBA Progress In Goals Narrative

--RBA Cash Rate Hike Could Be Delayed By Sluggish Inflation Ahead

By Sophia Rodrigues

     SYDNEY (MNI) - Australia's recently-released second quarter inflation

contained a few details that could challenge the Reserve Bank's narrative for

further progress in returning inflation to target, raising the risk that the

cash rate would be on hold for longer than previously thought.

     Money markets are currently pricing in a near 50% chance of a 25bps hike in

the RBA cash rate by August 2019, but 'inflation progress' makes even that look

overpriced.

     In any other situation, market pricing for a rate cut would be the right

bet but Governor Philip Lowe has clearly stated he would tolerate low inflation

provided the labor market is improving. Given the outlook jobs outlook remains

buoyant, the RBA is unlikely to consider a rate cut on the back of any subdued

inflation outlook, with an extended period of the cash rate at 1.5% is a more

plausible scenario.

     Data published last week showed headline CPI inflation rose 0.4% q/q in Q2,

falling short of economists' expectations for the seventh straight quarter.

Inflation y/y, however, crept into the RBA's target band for the first time in

five quarters and only the second time in 15 quarters, with a 2.1% rise.

     Underlying CPI rose 1.9%, in line with expectation, although slowing from

an upwardly revised 2.0% rise in Q1.

     There were several soft themes in the inflation data and while the RBA

acknowledges them, they are of the view that they are either one-offs or

unlikely to lead to any meaningful inflation forecast change in the Statement on

Monetary Policy due on August 10.

     Significantly, the RBA is relying on above-trend GDP growth to lead to

slightly faster acceleration in wage growth and for inflation to progress to the

mid-point of the target band.

     Indeed the RBA forecast for inflation to slowly progress towards the target

mid-point is almost entirely dependent on the wage growth forecast.

     --INFLATION OUTLOOK

     However, the RBA may be a little optimistic, placing too much emphasis on

the erosion of spare capacity putting upward pressure on wage growth, and little

emphasis on past inflation outcomes being an important determinant of future

wage growth.

     Although y/y CPI entered the RBA's target band, it is not expected to

accelerate further, with some economists forecasting a deceleration to 1.7% by

end-2019.

     If headline CPI remains stuck around 2.0% this year and the next, it would

be difficult for wage growth to accelerate, given many enterprise agreements,

and even employers outside that, use CPI as a starting point for wage

negotiations.

     Low headline CPI has other implications too, especially in the insurance

sector where premium growth is widely linked to inflation.

     One example is inflation across the health sector, up 3.4% y/y in Q2 -- the

slowest pace of increase since 2001. A dampening factor was a slowing in annual

health insurance premiums, up 3.95% in 2018, the lowest rate of increase in 17

years. 

     There is a wider implication of this. As premium revenue grows at a slower

pace, insurance companies are likely to respond with cost-cutting measures, and

slower wage increases, which, in turn, will impact the future inflation outlook.

     --WATCH UTILITIES

     The Q2 data also showed other headwinds to the inflation outlook. Rent

inflation, for example, was flat q/q compared with a 0.2% rise in Q1, marking

the first such outcome in 24 years. Economists expect rental inflation to remain

weak but offsetting this would be rising cost for dwelling construction. The RBA

is also relying on this to put upward pressure on housing inflation.

     To some, the game-changer for the inflation outlook is the fall in

household energy prices, with electricity prices down 1.3% q/q in Q2 and gas

prices falling 2.2%. Until recently, rising electricity prices were expected to

remain a meaningful inflationary pulse, at least through 2018, and possibly into

2019 now some see prices falling this year and first half of next.

--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com

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