CPI shoots higher – Rates and AUD up with it

The CPI data fro Q2 2011 was higher than expected this morning printing a rise of 0.9% against headline expectations of 0.7% and for an annual rate of 3.6% against 3.4%. It’s only 0.2% but in the arcane and nuanced world of economic forecasting that difference is as wide as the Grand Canyon – so the talk is now of RBA rate hikes once again.

The AUD has broken up through this years high and currently sits at 1.1042 and likely to go higher once Europe walks in this afternoon. 3 year swap rates have risen, now sitting at 4.955% whereas they were at 4.80% earlier today and in general there is a little bit of excitement in the markets again as the ground has shifted once more.

But has it? To answer that question we need to do a number of things.

Firstly we need to think about where the RBA’s head is at with regard to the economy and particularly inflation. We need to think about what the impact of this number will have on markets and on people, remember when the pieces of the puzzle are put together they rub on each other and change shape. So this outcome in and of itself changes the future. We also need to dig into the data to see what drove it and to a certain extent we also need to accept that in the grand scheme of things 0.2% isn’t that big a miss and that it has caused natural market volatility, both in thought and price action, and not over think it or extrapolate it out too far.

For the RBA we know this was a critical number, they told us as much in the minutes to this months Board meeting.

Members noted that the CPI outcome for the June quarter, to be published later in the month, would be important in helping to shape views about inflation, and therefore the future path of interest rates.

So to the extent that the market was expecting 0.7% across all measures (headline, trimmed mean and weighted median) and we got 0.9% it brings this comment from the minutes starkly into play. Indeed the fact that the Board left this as the final comment in the minutes means they did not want it to be missed. It’s placement highlighted and reinforced its importance.

This morning  I wrote a blog where I said that I didn’t think the Governor gets the structural nature of the savings increase but in the context of this inflation debate that probably matters little to the RBA. What he does get, and is very concerned about, is that he, his staff and his Board do not want to make the same mistake of Mining Boom Mark I. That is, the RBA gave the economy the benefit of the doubt but inflation and inflation expectations skipped away from them and by the September quarter of 2008 we had a headline annual  rate of inflation of 5%. Even though back then I was forecasting rate cuts, largely for the same reasons I see now – household troubles, its fair to say that only the near collapse of the global economy saved Australians and the RBA from more inflation and an RBA dilemma as falling growth was about to become coincident with rampant inflation.

That is why they put so much weight behind the mining boom and it’s impact on the economy and inflationary pressures. They are generals fighting the last war but in many ways they’d argue the war is still with us. The RBA is acutely aware and worried about inflation and this is bigger than they had wanted or expected.

But is it enough to make the RBA hike in August? I doubt it given the changed rhetoric we have seen in the past two months Statements and Minutes from the Board meetings and also with regard to Stevens speech yesterday on Consumer Caution. He may not get it but it is a risk around his central tendency, that much he does understand.

For the markets we know that they have reacted as they always have done when a number is away from consensus expectations. Rates have risen, the AUD has rallied and the talk of rate hikes from the commentariat is once again strong. Notes subsequent to the release of the data from both the CBA and HSBC say that there is a Q4 rate hike coming but that the risk is of sooner action.  The NAB says that,

This number scotches any prospect of easing anytime soon (along the lines of what the market had priced) and puts hikes back on the agenda for discussion at Martin Place in the months ahead

While Westpac has dissected the data and reckons that the breakdown looks a little wonky noting that,

…both headline and core numbers are heavily influenced by another questionable upside surprise on the heavily-weighted deposit and loan facilities sub-component…We note with relief that the ABS plans to change this troublesome sub-component from the CPI from the September quarter – dropping the problematic ‘indirect’ estimate of costs for one based on ‘direct’ charges.

What you notice here is that the protagonists in our play are reviewing the data in accordance with their view of and call of the direction of interest rates. This is what we call data mining and must be avoided at all costs.

So what do we think?

We think this is an unwelcome acceleration in inflation at a time when the Australian Household sector and consumers generally have neither the mood nor the wit to take another interest rate hike. This number is a genuine and clear threat to our call that rates will be on hold for a while and then down because we know that the RBA is frightened, not too strong a word given the experience of Mining Boom Mark I, and may feel compelled to hike. If for no other reason than to fire a shot across the bow of any and all sectors, including wage negotiators, who may lift their eyes and inflation expectations to a higher plane.

We don’t think they’ll act on this inflation number alone. If I gaze into my slightly scratched crystal ball I would say that next Tuesday’s statement that accompanies the RBA Board meeting and interest rate decision will highlight the increased risks associated with this unexpected and uncomfortable uptick in inflation but also note enduring household caution and the uncertainty offshore. But, neither the RBA nor any of us will want to see a number like this repeated when the September quarter CPI is released on October 26th.

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

 

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4 Comments on “CPI shoots higher – Rates and AUD up with it”

  1. Richard Says:

    Greg, I have been following your posts with interest and this one and some of the other recent ones on the issues in the US strike a particular chord with my thinking. Out of interest, do you think that part of a solution could be a resources specific tax used to take a bit of the heat out of the economy more generally and giving the RBA some scope to decrease rates? I would have thought this would give some scope to give interest rate relief to the economy which may help other sectors.

    Cheers

    Richard

    Reply

    • lighthousesecurities Says:

      Hi Richard,

      We have to find a way to capture value for future generations from the mining boom. So yes I think you are right we should have a way to do this. But regardless of whether you agree or not with the carbon tax the reality is that mining now faces another impost so the question of how Australia harvests this dividend has become a little harder.

      i would argue however that while you and I agree that this might take some pressure off the rest of the economy I don’t think the RBA feels there is a need to. the theme coming through all their speeches is that the structural adjustment underway is just how it is and the rest of the economy just has to adjust. Their attitude might be different if, like me, they thought that the spending dought was structural. But they clearly see it as transient which the Governor reiterated again in his speech yesterday.

      Cheers – Greg

      Reply

  2. M-Bay Resident Says:

    So in looking at the contributors to the quarterly increase in some detail:
    Food up 1.4% (primarily due to 128% increase in bananas due to the weather impacts, offset by veggies down 10%)
    Transportation up 1.2% (due to automotive fuel up 4% and transport fares up 1%)
    Financial and insurance services up 1.6% (this includes the deposit and loan facilities you mentioned up 2.1% and insurance premiums etc up 1.6%)
    Household contents and services up 1.5% (increase due to furniture 6% and linen prices 7.5%, according to ABS this is due to the cessation of specials offerd in March)
    Health up 2% (again due mainly to insurance premiums up 3.4%)
    and the final major increase was clothing and footwear up 2.5% (due to accessories 8.8% relating to jewlery, and we all know gold has been at its highest price)

    So looking at all the above increases I agree that the cost of living is going up, and the RBA have the task of limiting how quickly it does so. BUT these increases also highlight you constant theme of a consumer under pressure as hardly any of the above appear to be demand driven. I’ts not the consumer driving the prices up.

    Reply

    • lighthousesecurities Says:

      Yep dead right…it is not consumer driven inflation. But the RBA is worried that inflation expectations will skip away.

      I strongly believe that weaker aggregate demand will ultimately pull down inflation but as John Mauldin like to say “when you only have a hammer everything looks like a nail” – that’s monetary policy for you.

      Reply

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