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Daily Global Commentary

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Australia: A Retreat in Imported Inflation Blurs Interest Rate Outlook

Tue, Oct 24 2006, 03:02 GMT
by James Pressler

Northern Trust

Most analysts have already penciled in a 25 basis point rate hike after the November 7th meeting of the Monetary Policy Board of the Reserve Bank of Australia (RBA). This would bring the Overnight Cash Rate (OCR) up to 6.25%, where most expect it to remain through year-end. We are not refuting that further tightening is in the cards, but we have a lingering suspicion that the decision is not so simple. And the recent release of Q3 import and producer prices has given us all the more reason to reconsider the timing of the RBA’s next rate hike.

The first of the big three price pressure indicators – import prices – is usually a good barometer for how the CPI is affected by energy prices and other primarily external inputs. In Q2, the import index was up an annualized 6.2% from Q1, and the previous quarter witnessed an annualized jump of 12.0%. For Q3, the quarter-on-quarter rate contracted by 6.5%, suggesting some winding back of recent increases. On a year-over-year basis, import prices rose 3.7% in Q3 after posting a 6.8% gain during Q2 – a significant correction. Producer prices also stepped back from the Q2 figure of 4.5%, with just a 4.0% annual increase – a relief to local markets.

The final price indicator before the RBA’s meeting will be Q3 CPI, due for release tomorrow. After Q2 CPI made a significant leap on a year-over-year basis, up by an entire percentage point to 4.0%, and a strong rise in core CPI (CPI less food) from 2.8% to 3.2%, a rate hike seemed assured at some point. However, with import prices and producer prices having corrected from strong Q2 figures, there’s every chance that Q3 CPI will follow suit and fall back from recent highs and make the RBA’s meeting all the more difficult.

Now, we promised that a rate hike was still in the cards, and we stick by this decision – we just believe it will be triggered by growth in wage prices. The Q3 wage report is due for release on November 15th, and is likely to show further pressures coming from accelerating earnings growth in a tight labor market. This will provide the Board with the final piece of evidence necessary for hiking up the OCR, but the move will not happen until after the December 5th meeting. If tomorrow’s CPI report breaks step with the trend established by import and producer prices and rises further, the November meeting would be a fine time for a rate increase. However, if the RBA defies the consensus and stands pat, expect 25 a basis-point in December.

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Published on  Mon, Oct 23 2006, 00:00 GMT