By Gareth Aird, head of Australian economics at CBA:
Key Points:
- The headline CPI rose by a large 1.8%/qtr in Q3 22 and the annual rate surged to 7.3%.
- The RBA’s preferred measure of underlying inflation, the trimmed mean, increased by a very strong 1.8%/qtr and the annual rate stepped up to 6.1%.
- The inflation data printed stronger than our expectation, but we retain our call that the RBA will lift the cash rate by 25bp at the November Board meeting.
- However, we now incorporate our risk scenario into our base case for the RBA Board meeting in December. That is, we now anticipate a further 25bp rate hike at the December Board meeting, which would take the cash rate to 3.10% on our forecast profile (we expect that to be the terminal rate).
The quarterly pulse of inflation accelerated on the RBA’s preferred core measure – 25bp rate hikes at both the November and December RBA Board meetings now our base case.
Inflation surged in Australia over Q3 22, as was widely expected. The headline CPI increased by 1.8%/qtr and the annual rate popped higher from 6.1% to 7.3% (the market median forecast was 1.6%/qtr and 7.1%/yr; CBA on consensus for the quarterly increase but a touch lower on the annual rate at 7.0%). Recall that the headline CPI also rose by 1.8% in the June quarter and by 2.2% in the March quarter. A miss of 0.2ppts on the headline number is not a big miss in the scheme of things.
The trimmed mean, the RBA’s preferred measure of underlying inflation, rose by 1.8%/qtr over Q3 22 to sit 6.1% higher through the year. This outcome was significantly stronger than the market median forecast for a 1.5% increase on the quarterly print – CBA in line with consensus. The ABS upwardly revised the Q2 22 trimmed mean from 1.5%/qtr to 1.6%/qtr.
Interestingly, the other measure of underlying inflation, the weighted median, came in below consensus at 1.4%/qtr (vs 1.5% consensus). The annual rate of the weighted median is 5.0%, which means there is a large spread between the two measures.
The RBA used to take an average of the two underlying measures as their preferred core read on inflation. But since 2018 the trimmed mean has been the RBA’s primarily focus for underlying inflation.
The pace of underlying inflation as measured by the trimmed mean has accelerated over the September quarter. But the new monthly CPI indicates that the pulse of core inflation has held broadly unchanged over the past five months at 0.5%/mth. We will dissect and publish a note on the new monthly CPI next week.
There are no two ways about it – inflation is red hot in Australia right now, as it is in many parts of the world, and we expect the RBA will respond by raising the cash rate again at the November Board meeting next week. Indeed our call has been that the RBA will deliver one or two more 25bp rate hikes and then pause for an extended period (the base case was one further 25bp rate hike in November which would take the cash rate to 2.85%). Today we incorporate the second 25bp rate hike into our central scenario for the cash rate, which means we see the peak in the cash rate being 3.10%. Our expectation now is that the RBA raises the cash rate by 25bp at both the November and December Board meetings.
It is worth noting that the RBA’s aggressive tightening cycle (250bp of rate hikes between the May and October Board meetings) has had no impact on the June or September quarter inflation outcomes. Indeed the rapid recent rate hikes and our expectation of some further modest tightening is unlikely to shift the inflation needle over the December quarter; inflation is a lagging indicator. The impact of policy tightening will impact consumer inflation in 2023.
Key points in the data
The key components of the headline CPI printed broadly in line with our expectations. Food prices surged by a massive 3.2% over the quarter to be an incredible 9% higher over the year (fruit and veg spiked by 4.5% in Q3 22 to be a staggering 16.2% over the year – floods on the East Coast of Australia have played a large part in price rises and there will be some retracement in these price rises in 2023).
The housing group (+3.2%/qtr) was once again driven higher by the cost of building a home (+3.7%/qtr). Most of the other key components of the CPI posted more modest price rises, while clothing and transport prices record small declines.
Tradables inflation (i.e. imported inflation) continues to run hotter than non-tradables inflation (domestically generated inflation) in annual terms. Tradables prices rose by 1.5%/qtr to be 8.7%/yr. A fall in petrol prices kept a lid on tradables inflation over the quarter. Non-tradables prices rose by a stronger 2.0%/qtr to sit 6.5% higher over the year.
Non-discretionary goods and services prices rose by 2.0%/qtr to sit a massive 8.4% higher over the year. Non-discretionary inflation includes goods and services that households are less likely to reduce their consumption of, such as food, automotive fuel, housing and health costs. Discretionary goods and services inflation increased by 1.7% over the quarter to sit at a much lower 5.5% through the year compared to non-discretionary inflation. Discretionary goods and services may be considered ‘optional’ purchases.
Goods accounted for a little over three quarters of the 7.3% rise in the CPI over the past year, reflecting high freight costs, supply constraints and prolonged elevated demand. Goods inflation sits 9.6% higher over the year, while services inflation is 4.1% through the year. Services inflation has a strong positive correlation with wages – there is no wage price spiral in Australia like there is in many other jurisdictions.
Does headline or underlying inflation matter most?
The inflation basket can be carved up in a number of different ways. And economists and market participants have generally focused more on underlying inflation (or core inflation) rather than headline inflation when assessing the outlook for monetary policy in Australia. That is because the RBA have tended to put more weight on underlying inflation which attempts to abstract from the short-term volatility in some prices.
Quarterly movements in the headline CPI can be volatile because there are often big seasonal swings in the data, commodity prices and agricultural conditions can shift quickly, policy changes can impact quarterly outcomes and there may be infrequent price resetting. Indeed there was evidence of these forces in the data today.
The underlying measures of inflation better capture the inflationary pulse than the headline measure. But the RBA’s concerns around a potential shift in “inflation psychology” mean the headline rate of inflation at this juncture takes on added importance given it sits significantly higher than the underlying rates.
It is worth noting that many indexation clauses in the economy are linked to headline CPI. And wage negotiations generally take place with the rate of headline inflation as a key input rather than the underlying rate.
We expect the RBA to continue to emphasise the headline rate of inflation more than usual relative to the underlying rate in upcoming communication. The headline rate of inflation in Australia will peak at a higher level than the underlying rate (we expect headline inflation to peak ~7¾% and core inflation at 6½%). But the headline rate will also decelerate quicker than the underlying rate over 2023 due to both base effects and an expected decline in some components of the CPI that will be ‘trimmed’ out.
Implications for monetary policy
The RBA expect inflation to peak at 7¾% by the end of the year. Today’s headline inflation data was broadly in line with their implied profile. But the trimmed mean printed stronger than their expectations.
The RBA’s forecast from the August Statement on Monetary Policy (SMP) was for trimmed mean CPI to peak at 6.0%/yr in Q4 22. This forecast implied quarterly increases in the trimmed mean of ~1.5% in both Q3 22 and Q4 22. As such, the RBA will upwardly revise their forecast for the peak in underlying inflation in the November SMP next week. But they are likely to leave the peak in headline inflation unchanged at 7¾% (note that the Commonwealth Budget last night forecast headline inflation to peak at 7¾% in Q4 22).
We expect the RBA to raise the cash rate by 25bp at the November Board meeting next week. Our full preview on the RBA next week will be published on Friday (28/10).
Our detailed take on today’s CPI will follow.
