REPEAT: MNI: CPI Uptick Hinted In New RBA Spare Capacity View

Repeats Story Initially Transmitted at 04:10 GMT May 3/00:10 EST May 3

--RBA Still Cautious on Reduced Slack Pass-through to CPI

--Unclear If June 2020 Forecast CPI Will Rise to 2.5% from 2.25% 

By Sophia Rodrigues

     LONDON (MNI) - The Reserve Bank of Australia's new description of spare

capacity in the economy this week which places it in the context of growth,

points to an uptick in its inflation outlook when the central bank publishes its

latest forecasts Friday.

     In the cash rate statement Tuesday, the RBA talked about the central

forecast for growth to pick up a bit above 3% this year and the next, and said

that "this should see some reduction in spare capacity in the economy."

     This notable reference to growth marks the RBA discussing spare capacity

beyond its usual labour market terms, though the central bank's caution over the

pass-through between reduced slack and consumer price inflation should also be

noted. 

     It therefore remains unclear if the RBA's forecast for inflation in June

2020 will be revised up to 2.5% when its updated projections are published on

Friday in the quarterly Statement on Monetary Policy. In February, the RBA saw

both headline and underlying inflation at 2.25% by June 2020.

     The discussion of spare capacity beyond the labour market is important

because it impacts both the RBA's growth and inflation outlook. 

     The RBA's preference in recent years has been to refer to spare capacity in

the economy in labour market terms only, believing it to be the best gauge of

capacity pressures. Given the focus on wage growth, the discussion has always

centred around how a decline in spare capacity in the labour market is important

for wage growth to accelerate.

     The RBA regards a faster rise in wage growth as important for both its

inflation outlook and for growth because a faster rise in income versus debt is

key for stronger household consumption.

     --RECORD HIGH CAPACITY UTILIZATION

     It wasn't too long ago that the RBA used to discuss spare capacity in

product markets in its quarterly policy statements.

     The last such reference was in the November 2016 quarterly policy statement

when it said that the decline in spare capacity in various product markets was

expected to lead to a gradual pick-up in inflationary pressures, though some

product markets were likely to experience surplus capacity for some time.

     The current discussion has stemmed mainly from a rise in capacity

utilization around the record high levels evident in business surveys.

     The Australian Industry Group's services index published earlier Thursday

shows capacity utilization at a record high 82.4% in April, well above the

long-term average of 75.7%. In the manufacturing survey, capacity utilization

eased slightly to 79.9% in April after touching a record high in March.

     AI Group's construction index also showed capacity utilization posting a

relatively high 79.3% in March, which was 0.4 points above 12-month average. 

     National Australia Bank's Q1 business survey showed capacity utilization

rise further to 82.7%, together with increases in firms' capital expenditure and

employment plans for the next 12 months.

     --WORD OF CPI CAUTION

     In 2015, the RBA published an interesting research article on capacity

utilization and the implications for investment, labor and prices. The article

showed a direct relationship between capacity utilization and consumer price

index inflation but one which is weaker than for producer prices. This may be

one reason why the RBA may be cautious in upgrading inflation. 

     The article concluded that for firms in the more capital intensive

goods-related industries, a high level of capacity utilisation may reveal an

impetus to hire more labour and to invest in the capital stock, while for

services firms it is more likely to reflect an incentive to hire more labour

only. 

     "Consequently, movements in aggregate measures of capacity utilisation are

likely to contain information about the labour market, while the implications

for business investment are likely to be identified at a more granular level."

     The article said the relationship between capacity utilisation and consumer

price pressures is weaker than it is with upstream domestic price pressures

which may, in part, reflect the effect of well-anchored expectations regarding

consumer price inflation.

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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