Rate cut of 0.25 percent possible: Bill Evans, Justin Smirk

GUEST OBSERVER

The Q2 CPI printed 0.4percent compared to Westpac’s forecast for 0.5 percent. The market median was 0.4 percent. The annual rate is now just 1.0 percentyr compared to 1.3 percentyr in Q1 which is the lowest rate of annual inflation since June 1999.

The core measures, which are seasonally adjusted and exclude extreme moves, rose 0.48 percent compared to the market’s expectation of 0.4 percent rise. Westpac’s forecast was lower at 0.35 percent. In the quarter, the trimmed mean gained 0.51 percent while the weighted median lifted 0.44percent. The annual pace of the average of the core inflation measures is now 1.5 percent from 1.5 percent in Q1 (Q1 was revised from 1.4 percentyr).

The six month annualised pace of core inflation came in well below the band at a very 1.3 percentyr pace, this is the fourth quarter in a row it has been below the bottom of the target band and the lowest six month annualised pace since the 1.3 percenty print in March 1999 (a seventeen year low).

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Helping to hold the core measures down, but not pushing the pace even lower, was the modest 0.4 percent rise in housing cost which is a small lift from the 0.3 percent in Q1. Rents held a very subdued rise of just 0.2 percent (from 0.1 percent in Q1) but of more interest was the 0.9 percent bounce in house purchases from the very mild 0.2 percent in the March quarter. In the quarter dwelling prices rebounded in Sydney (1.5 percent from 0.5 percent in Q1), Melbourne and Brisbane (both 0.9percent from 0.4percent) easing fears that we may be seeing a significant slowdown in housing costs which would pin down both core and non-traded inflation.

Non-traded prices rose 0.4 percent in Q2 as a boost to health costs (2.6percentqtr) added to the lift from housing costs. 

Traded goods prices rose 0.6 percentqtr following a very weak –1.4percent in Q1. The June quarter saw something of a reversal for the auto fuel prices (+5.9 percentqtr vs –10percent in Q1) and fresh fruit & vegetables (1.7percent vs –4.3 percent in Q1). However, excluding fuel, food and tobacco traded goods rose a modest 0.3 percentqtr which is only a modest bounce from the 1.3 percent decline in Q1. This left this ‘core’ measure of traded goods prices at a very modest 0.3percentyr.

Our March quarter observation about across the board weakness in Australia retail prices was modestly reversed in the June quarter with some recovery housing costs, a lift in health costs and some sign of AUD pass-through with 2.0 percent lift in clothing & footwear prices. As such, it does provides at least some near term relief from fears that the outlook for inflation could be significantly lower than what the RBA is currently expecting. 

It does not, however, remove those fears as falling food prices (ex-fresh fruit & vegetables), recreational goods and car prices highlight that the pressure on margins remain. 

Outlook for the RBA – Bill Evans, Chief Economist. 

The underlying measure of the inflation printed 0.48percent to two decimal places. That was above our forecast of 0.4percent. Annual underlying inflation held steady at 1.5percent – outside the 2-3 percent target range.

We pointed out in our note last week that the risk in the number was in the “house purchase” or “construction costs” that printed 0.9percent compared to our expectation of 0.3percent. However the other housing component that captures the housing effect – rents remained subdued at our forecast number of 0.2percent.

The RBA sees the disinflationary “forces” coming from weak wages growth; tight retail margins; and slowing housing costs while it is less convinced about the “pass through” effect of the fall in the AUD.

Evidence of sagging wages growth and disinflationary global pressures provide little evidence that “something will turn up” to reverse this ongoing “below target zone” performance.

The retail margin squeeze was apparent with food; household goods; and cars, although not in clothing and footwear. The housing slowdown eased in the quarter.

Recall that the RBA’s own forecast for underlying inflation for the year to June quarter was 1.5 percent – so this number will be in line with their forecasts.

Also recall that the RBA forecast for underlying inflation in 2016 is 1.5 percent and 2.0 percent in 2017.

That forecast, in May, used “market pricing” which at the time incorporated a further full rate cut by year’s end.

We can only assume that the Bank  will continue to accept that another rate cut , some -time in 2016, will be necessary to achieve these “barely acceptable.” forecasts in the context of a Bank that targets a 2-3 percent inflation “zone”.

Another way to look at this number is that at 0.48percent still “annualises” to a “below target range” number. Of course, the 6 month annualised number is running at 1.3percentyr.

In our view this report is still consistent with a rate cut of 0.25 percent next week.

However because there was some “bounce back” in the number the case can be made to wait if there is a fundamental philosophical resistance to cutting.

Evidence of that “resistance” softened in the recent Board minutes where the Board appeared to be more cautious around both the labour market and the housing market.

With the market expecting a rate cut and most commentators supporting that position the best policy still appears to be another cut.

BILL EVANS is chief economist of Westpac. Justin Smirk is ‎senior economist, Westpac Group and can be contacted here.