Fresh from our Bill:
This number will come as a positive surprise for the RBA. Recall that following the 0.9%qtr print for underlying inflation for the December quarter they raised their forecast for underlying inflation to 3%yr from 2.5%yr. That implied they expected a probable 0.8%-0.9% print for March quarter underlying inflation. The implication is that the Bank expected that there would be 2-3 period inflationary impulse from the fall in the AUD in 2013, as their view on the state of underlying demand would allow for the same sort of pass-through or margin widening they felt they observed in late 2013.
They did not however adjust their assumption that the pace would ease back to 0.6%qtr for the second half of 2014. That meant they expected the impulse effect from the AUD to “linger” for at least one more quarter but not to become embedded in the system – weak wages growth encouraged that expectation.
Specific evidence around the “fade out” of the AUD effect can be found in household goods, recreation (both domestic & overseas holidays fell in the quarter) and clothing & footwear.
Evidence that the impulse effect only lasted for one quarter and was also offset by some weaker non-traded forces (particularly around housing, health and education, all of which printed well below our forecasts) should signal to the Bank that the economy was not strong enough to sustain a more drawn out impulse effect, while weakness in the non-traded sector was also containing these pressures.
This result will therefore mean a number of important things for the RBA:
1) There is going to be limited implication for inflation if the AUD was to ease off back towards USD 0.90 from current levels.
2) The economy might not be as strong as they had expected – note that IMF forecasts (largely provided by Treasury) are lower than recent RBA forecasts.
3) There would appear to be little risk in restoring a stronger rhetoric about the AUD. Recall that following the 0.9% print for core inflation in the December quarter the Bank dropped its “uncomfortably high” description of the AUD. The AUD lifted from USD 0.87 to near USD 0.94 over the subsequent 6 weeks. (In December, when the AUD stood at USD 0.91 it was described as “uncomfortably high”.)
4) We expect that the AUD will revert back to our USD0.91 target by June but, if that traction is not achieved over the next few weeks, the Governor may well restore the “uncomfortably high” language in the Statement following the May 6 Board meeting. However, given the more encouraging domestic data on consumer spending, housing and employment it will not restore its easing bias.Westpac retains its call for the rates to remain on hold until the second half of 2015.
The details
There are a number of surprises in any CPI release, with 90 items to forecast before calculating the expected trimmed mean. On this occasion we note that the weakness was broad brush rather than concentrated. In effect, there were surprises across multiple categories that were consistent in direction – most coming in on the low side. The accumulation of these outcomes led to the big surprises on the headline, core and analytical categories. In particular, the very soft 0.7%qtr rise in non-traded goods and services caught our attention and will certainly garner the RBA’s, as will the fact that if you remove administrative charges (such as utilities, health and education) from the non-traded index this series fell 0.2%qtr, the first recorded fall since the March quarter of 2009. Also, the 6 month annualised pace of core inflation eased from 3.0% a quarter ago to 2.8%.
By category and item, housing costs rose a very modest 0.6%qtr led by a surprisingly soft 0.1%qtr rise in new dwelling purchase costs. We had been looking for a more average rise around 1%qtr. In addition, the rise in health and education was less than normal for Q1, which may explain the softer 0.1%ppt from seasonality compared to 2013Q1. Discounting returned for household goods and clothing after the Q4 margin build (-1.5%qtr and -2.1%qtr respectively), and by more than we had anticipated given the weaker AUD. In addition holiday travel (both domestic and international) fell further than anticipated in the quarter. Elsewhere, food prices were on expectations but car prices rose and audio visual & computing did not fall as much as expected. As a result, traded good prices rose 0.4%qtr.
The inflationary impulse clearly faded as we moved into 2014.
AUD Strategy Comment
AUD/USD looked comfortable ahead of the CPI data, at 0.9375. The sharp downside surprise on the core inflation readings sparked a quick selloff to around 0.9320. The attempt to hold this support level only lasted until the China PMI data, which saw another round of AUD selling to 0.9300 despite meeting consensus on the headline reading. Given that rates markets weren’t pricing in an RBA hike until mid-2015 anyway, AUD price action is poor, giving the impression that bears have been waiting for an opportunity such as this to resume selling.
