Australia | Jan 25 2007
By Chris Shaw
Immediately following the release of Australia’s December quarter CPI data yesterday the bond and currency markets reacted by removing the premium that had been built in based on the expectation the data would be followed by an increase in official interest rates next month.
On Credit Suisse’s estimates what had been a 40% chance of a further rate hike quickly fell to a 4% chance, but it raises the question are the markets correct in assuming rates are on hold.
Yes is the majority answer, as most economist have responded to the data by assuming rates are now on hold in coming months, with some, such as GSJB Were, suggesting the next move in rates will be a cut in the final quarter of 2007.
These views reflect the numbers showing headline inflation fell in the December quarter by 0.1%, against market expectations of an increase of around 0.2%. ABN Amro notes the headline number was helped by lower fuel and fruit prices, but of more significance were the measures of underlying inflation, which also rose by less than expected.
This, the broker suggests, indicates lower fuel costs are feeding into the system faster than had been expected, which should allow the Reserve Bank of Australia (RBA) to hold rates steady when it meets next month. The broker also sees potential for the bank to shift to a neutral stance when it releases its “Official Statement on Monetary Policy” in May.
Credit Suisse also sees rates as on hold, but expects the RBA to maintain its tightening bias, as it suggests this would help anchor inflationary expectations. It also sees such an approach as prudent given ongoing tightness in the labour market, which could produce some wage inflation pressure.
ANZ Bank sees the result as indicative underlying inflation has peaked, as it notes the RBA’s favoured quarterly measures recorded their lowest outcomes since the March quarter of 2005. Westpac tends to agree, as the bank has dropped its expectation of a rate hike next month in favour of no change over the course of 2007. Both banks agree the risk remains to the upside though given the labour market pressures, the recovery in housing and the impact of the drought.
The dissenting view on the data is offered by Stephen Koukoulas of TD Securities, who argues the CPI outcome shows inflationary pressures are actually intensifying rather than weakening.
In his view the low outcome was the result of some one-off factors such as lower fuel prices and the China effect, where prices are being kept low as China exports deflation through its cheap manufacturing sector.
He argues a look at the changes in the components of the CPI Index shows signs inflation is trending up when those sectors influenced by China and the manufacturing effect are taken into consideration.
As an example, around 17% of the CPI index is made up of clothing and footwear; furniture and furnishings; household appliances; audio, visual and computing; sport and recreation equipment; toys and games and motor vehicles. Of these, all but motor vehicles and furniture and furnishings fell in the quarter from their year ago levels, but if these sectors were excluded from the CPI calculation the result would have been a 4.1% annualised increase in the quarter rather than the 3.3% rise recorded.
Taking out fuel prices the CPI would have actually risen by 4.5%, which is higher than the 4.2% outcome recorded in June last year. As a result, Koukoulas has not been swayed from his view a further increase in rates is likely in coming months, as it would only take a slowing of the China effect or a jump in fuel prices to make the outcome very different from what was announced yesterday.