Australia | Apr 23 2007
By Chris Shaw
While there is not a strong historical correlation between the Producer Price Index (PPI) and the Consumer Price Index (CPI), today’s lower than expected PPI data showing a flat outcome for the March quarter compared to market forecasts of a 0.6% increase is still good news for Australian interest rates in some ways.
As Riki Polygenis, acting senior economist at ANZ Bank notes, the PPI outcome implies less potential for pass-through price increases from manufacturers, which in turn implies less pressure on the CPI.
The problem though is the CPI and the PPI don’t measure the same components, which weakens the relationship between the two. So, while the PPI outcome was better than expected and according to TD Securities global strategist Stephen Koukoulas should make the Reserve Bank of Australia (RBA) happy, it likely only delays any increase in interest rates rather than taking it off the agenda.
Koukoulas points out especially manufacturer output prices were up only 3.8% for the year, which was good news for inflation, but this was offset by increases in construction industry prices of 0.9% for the quarter and a 1.4% increase in property and business service prices, meaning there are still inflationary pressures in the economy.
He notes the market is now pricing in only a 50% chance of a rate increase at the RBA’s meeting next month but there remains a 66% chance rates go higher by June, so today’s number is likely to just delay what he regards as inevitable.
ANZ has not changed its expectations, suggesting the lack of any solid relationship between the PPI and the CPI means the RBA is still likely to hike when it meets next month. The bank is factoring in a 0.25% increase, based on its CPI forecast of 0.7% for the March quarter and 31% for the year for the headline rate and 0.7% and 2.9% for the core rate.
GSJB Were disagrees, expecting the RBA will remain on hold as in its view there is downside risk to inflation forecasts as the moderation in PPI that begun to appear last quarter now seems to be spreading through the broader economy. Annual figures suggest this is the case, the broker noting the PPI is now at 2.8% year-on-year, down from 4.5% just three quarters ago.
Westpac has adjusted its CPI forecast on the back of the PPI outcome, lifting its CPI expectation for the quarter to 0.75% from 0.7% previously thanks to the increase in house construction prices. As the bank notes, the key for the CPI, which it agrees is more important than today’s PPI, is that some factors helping drive down the PPI won’t do the same for the CPI as the composition of the two indices is different. As an example it notes both education and health are in the CPI index, and both have risen in the period.