Australia | Apr 21 2008
By Greg Peel
Cast your mind back to the December quarter of 2000. Australia was on a high having just hosted a glowingly successful Olympics Games, which had been preceded by a construction rush. However, we were also bitching about the recent introduction of a 10% GST and the weakness of the Aussie peso, which at US$0.55 was making everything imported frightfully expensive. Indeed, there was quite a jump in wholesale inflation as a result of all of the above.
That was the last time wholesale inflation had pushed up to the sort of levels Australia experienced in the March quarter just past. Today’s announced Producer Price Index increase of 1.9% was the highest number ever recorded since the numbers began being collated in 1998. A December quarter increase of a mere 0.6% pushed annual wholesale inflation to 2.8%. Today’s rise has taken it to 4.8%. Economists didn’t even come close to predicting a 1.9% result, with consensus settling at around 1.1% and the high marker still only being 1.4%.
This time there’s no Olympic Games, no new tax and the Aussie has become a dollar again at US$0.94. The bulk of the increase came from petrol (10.4%), construction (1.8%) and utilities (electricity, gas, water) (3.1%). These three categories far exceeded economist expectations. But grain, sheep and beef prices shot up 4.3%, and rises were experienced in tobacco, motor vehicles, road and freight transport and real estate agent fees. Hardly anything went down.
The first question that leaps to mind is: What on earth are we going to get as a Consumer Price Index on Wednesday? If the jump in the CPI matches the jump in the PPI might the Reserve Bank suddenly change its mind again about raising rates. Is it 7.5% in May?
No. Economists have not changed their views on a rate rise. The RBA will remain on hold. However, a higher PPI does point to rates remaining on hold, and not being cut, well into 2009.
For starters, there is never any direct correlation between PPI and CPI. If retailers are forced to cop the increases in profit margins because they know consumers won’t pay higher prices then we won’t see an equivalent 1.9% in the CPI. For example, on the basis of the PPI rise Westpac has only increased its CPI expectation from 1.0% to 1.1% for an annual rate of 4.1% instead of 4.0%. TD Securities suggests the RBA might rethink on a rise above 1.3% but sees such a rise as very unlikely. If monthly US data are any indication, March saw a 1.1% rise in PPI in the US which similarly shocked economists but only a 0.3% rise in CPI.
The other factor to consider is that producer prices lag the economy, so this number is really a representation more of the December quarter than the March quarter. In December the Australian economy was still boiling along – it’s only been in the last month or so that economic indicators have turned decidedly negative. The RBA is well braced for a strong March CPI result, but is already looking ahead to when the easing of domestic demand, now evident in the forward indicators, translates into an easing of inflation over time. TD Securities suggests this quarter could see the “high point” in inflation.
So it’s no 7.5% but 7.25% could be with us for a year or more.
From a stock market perspective, the CPI will be a number to watch irrespective of no expected rate rise. If the rise in the CPI is nowhere near as big as the rise in the PPI that means businesses are seeing their profit margins collapse. This would not bode well for first half earnings.