Market Wire: RBA: Inflation challenges remain

CalendarApril 24, 2024
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Australian Q1 CPI inflation positively surprised consensus predictions, and looks to be a touch above what the RBA’s forecast profile was penciling in. The result has generated a jolt across the Australian bond market and boosted the AUD as RBA rate cut expectations were pared back.

In terms of the numbers headline inflation eased from 4.1%pa to 3.6%pa in Q1 (mkt 3.5%pa), while core inflation (i.e. trimmed mean) nudged down to 4%pa (from 4.2%pa last quarter vs mkt 3.8%pa). Positive base-effects in various things like food, utilities, and ‘goods’ as last year’s larger increases rolled out of calculations and the rebalancing in demand/supply across the economy on the back of softer growth and healing supply-chains have helped to mechanically pull down annual inflation from its late-2022 peak.

However, stickiness across domestic and services prices remains. And this is the focus (and concern) for the RBA. Rents rose strongly in Q1 (+7.8%pa) as the imbalance in housing remains in place. Other things like a jump in education fees at the start of the new year also flowed through, as did a rise in insurance premiums. More broadly, services inflation, which is tethered to the labour market and wages, is running at 4.3%pa. While below its peak this is still more than 1.5%pts above its pre-COVID average. The underlying crosscurrents are also observable in the tradables versus non-tradables split. The former (which reflects global conditions) has tumbled to just 0.9%pa, but the latter (which is linked to domestic conditions) is tracking at 5%pa.

Things are still (slowly) heading in the right direction, but as it is proving to be in many other countries, the last leg of the inflation slowdown is proving to be a tough nut to crack. And we doubt the RBA, who was quite pragmatic and more constrained than other central banks during the tightening cycle, will want to start to reverse course too soon. Given the resilience in the Australian labour market and the slow-moving wage dynamics in Australia because of the high prevalence of multi-year Enterprise Bargaining Agreements, the last leg of the fight to get domestic/services inflation down to where it needs to be could take some time.

The Q1 CPI data, coupled with the still tightish labour market, the incoming stage 3 tax cuts, likelihood of additional cost of living relief measures in the upcoming Federal Budget, support to aggregate demand from the larger population, and signs of improvement in industrial activity out of China underpin our long held belief that the RBA will lag its peers in terms of when it starts and how far it goes in the next global easing cycle. We continue to think that the start of a modest and limited RBA easing cycle remains a story for late 2024, at the earliest.

For the AUD, we feel that diverging monetary policy expectations, widening yield differentials, and Australia’s sturdier economic fundamentals should support pairs like AUD/EUR, AUD/GBP, and AUD/NZD. With respect to AUD/USD, as outlined in our various recent commentary, we believe that a grind higher should be anticipated over the medium-term, and that despite the rebound over the past few days there is scope for a further lift near-term given: (a) bearish market positioning (as measured by CFTC futures) is quite large; (b) the upswing in the USD may have run its course as US interest rates and relative growth expectations might struggle to move much higher from here and with other nations such as Japan becoming more vocal about the extent of their currency weakness; (c) the improvement in risk sentiment and uptick in industrial metal prices; and (d) the capital flow and valuation support that is in place. Since 2015 (when Australia’s capital flow dynamics turned more positive) the AUD has only traded sub ~$0.65 ~7% of the time, while the average across our suite of models is indicating AUD fair-value is now ~$0.6650-0.67.


Peter Dragicevich

Currency Strategist - APAC

peter.dragicevich@corpay.com

Author

Peter Dragicevich

Peter Dragicevich

Currency Strategist - APAC

Peter analyses and forecasts global macroeconomic trends to draw out possible implications for interest rates, commodity pricing, and the FX markets for Australia and across Asia.

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