28 October 2016 AUSTRALIAN ECONOMIC DEVELOPMENTS. Inflation remains weak in the Q3 2016

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1 28 October 2016 AUSTRALIAN ECONOMIC DEVELOPMENTS This week s ABS inflation data (CPI) for the September quarter (Q3) showed headline inflation picking up to 1.3% p.a. (from 1.0% p.a.). Fruit and electricity prices were the main drivers. However, underlying or core inflation slowed slightly to 1.5% p.a.. This indicates that inflation is still structurally weak and that the drivers for the acceleration in headline inflation are not broadbased. With inflation still below the RBA s target band of 2 to 3%, this would allow the RBA scope to cut the cash rate further, should it need to do so to stimulate the economy. Also on prices, the ABS trade prices for the September quarter (Q3) show a decline in import prices and increasing export prices. This is good news for Australian consumers of imports but also for many agricultural and resources exporters, who are earning more from their exports. For Australian-based businesses the Producer Price Index (PPI) for the September quarter (Q3) confirm the weak price growth story that is still evident in the CPI. Of concern however, the PPI shows growth in prices for preliminary and intermediate inputs is outstripping growth in final demand prices, which points to continuing margin pressures within supply chains for businesses. Inflation remains weak in the Q Headline inflation (the Consumer Price Index or CPI) for the September quarter (Q3) 2016 picked up to 1.3% p.a., moving closer towards the RBA s target band of 2 to 3%. In quarterly growth terms, headline CPI grew by +0.7%, after more sluggish growth in Q2 (+0.4%) and no growth in Q1 (0.0% upwardly revised from -0.2%). The main contributors to inflation in Q3 were food & beverages (+1.7% q/q., +1.5% p.a.) and housing (+1.0% q/q, +1.8% p.a.), both of which account for large shares of the consumer basket of goods and services from which the CPI is calculated. At 1.3% p.a. in Q3, Australia s headline inflation is very low. This was the same headline inflation rate as in Q and Q Headline inflation has now been below the RBA s target band of 2 to 3% p.a. (on average, over the economic cycle) for two years, or eight consecutive quarters. This is the longest period that CPI annual growth has stayed below 2% since Underlying inflation (the average of the trimmed mean and weighted median measures of inflation, and a less volatile measure than headline CPI) moved lower in annual terms in Q3, at 1.5% p.a. (down from an upwardly revised +1.6% p.a. in Q2). This was the lowest annual rate recorded in the relevant CPI data series, which commenced in This indicates that inflation remains structurally weak, despite this quarter s increase in headline inflation. 1

2 Chart 1: CPI, headline & core Across the capital cities, annual inflation in Q was slowest in Darwin (0.0% p.a.) and highest in Sydney (+1.7% p.a.), Brisbane (+1.5% p.a.), Canberra (+1.4% p.a.) and Melbourne (+1.4% p.a.). The eastern capitals have generally experienced stronger price growth, while other capitals had softer inflation. This reflects stronger economic performance in the eastern states and particularly in NSW and Victoria in Slower growth is seeing a rise in spare capacity in the mining states, which were recently booming. Prices for tradable goods and services (accounting for around 40% of the CPI basket) lifted by 1.0% q/q in Q3 (up from +0.6% q/q in Q2), and headed higher (+0.7%) in annual terms. Prices for tradable goods and services are largely determined globally and are affected by movements in the exchange rate and by commodity prices (for agricultural and resources commodities). The increase in tradable prices in Q3 was driven by higher fruit prices (+19.5% q/q, +4.4% p.a.). Prices for non-tradeable goods and services (accounting for around 60% of the CPI basket) increased more modestly, at +0.5% q/q and +1.7% p.a. In annual growth terms, this was slightly higher than in the June quarter (+1.6% p.a.). Prices for non-tradeable goods and services are largely determined locally by labour, rent and other local costs. Non-tradeable price increases in Q3 were strongest in electricity prices (+5.4% q/q., +4.7% p.a.). Interestingly, a number of non-tradable goods have now been re-classified tradable (mostly food and beverages products), while some goods have been classified as non-tradable that were previously classified as tradable (including spirits, tobacco, and pharmaceutical products). This re-classification may help to explain some of the recent divergence in growth between tradables and non-tradables inflation; quarterly growth in tradables prices outstripped growth in nontradables in Q3, which was the reverse of the historical pattern of non-tradeables inflation typically outperforming tradables inflation. 2

3 Chart 2: Quarterly price rises, Q Looking across the categories of goods and services that are included in the CPI basket, food and beverages was the main driver of increases in CPI in Q3 (+1.7% q/q and +1.5%p.a.). Specifically, prices for fruit (+19.5% q/q, +4.4% p.a.) and vegetables (+5.9% q/q, +11.9% p.a.). This spike in fruit prices was mainly driven by adverse weather conditions (including flooding) in parts of the country, impacting some food producing regions and restricting supply. Housing prices also added upward pressure to the CPI in Q3 (+1.0% q/q, +1.8% p.a.). In particular, electricity prices (+5.4% q/q, +4.7% p.a.) increased due to a jump in wholesale electricity prices in the eastern and southern states (notably south Australia). Higher property rates and charges also added to housing costs (+4.0% q/q, +4.0% p.a.), probably because they are indexed to the rise in the price of new dwelling purchases by owner occupiers. This protracted period of low inflation will allow scope for monetary easing (lowering the cash rate) by the RBA if it considers this necessary. The RBA lowered the cash rate by 25 basis points in early August to 1.5% after the release of weak inflation data for the June quarter (Q2). The RBA may consider lowering the cash rate further in coming months. It will consider a range of factors (including the labour market and balance sheets across the economy) and has said it expects inflation to pick and eventually return to the 2 to 3% target range. The Q3 inflation results are broadly in line with the RBA s expectations. 3

4 Table 1: Key CPI Numbers, September quarter (Q3) 2016 Quarterly change (% q/q) Annual change (% p.a.) Sep-16 Jun-16 Sep-16 Jun-16 Headline CPI Trimmed mean Weighted median Core CPI (average of trimmed & weighted) Tradable goods and services Non-tradable goods and services Goods Services Capital cities Sydney Melbourne Brisbane Adelaide Perth Hobart Darwin Canberra Import prices down, export prices up in Q3 ABS export and import price indexes show that in Q3, the import price index fell by 1.0% q/q and 4.8% p.a., while the export price index increased by 3.5% q/q but was 5.4% lower over the year to Q3. Generally, imports were cheaper while Australian exporters were receiving more for their exports. This is good news for Australia s balance of trade, terms of trade and national income. The largest import price declines in Q3 were for chemicals products including: Crude fertilizers (-21.2% q/q, -44.1% p.a.); Other fertilizers (-10.0% q/q; -26.0% p.a.); and Non-primary plastics (-11.6% q/q, -14.2% p.a.). The largest export price increases in Q3 included: Meat and meat preparations (+10.9% q/q, -1.9% p.a.); 4

5 Sugar and sugar preparations (+18.9% q/q, +26.2% p.a.); Gas (+9.6% q/q, -24.7% p.a.); and Animal and vegetable oils and fats (+8.5% q/q, +38.8% p.a.). Chart 3: Import and export price indexes Producer prices confirm energy price increases for businesses in Q Producer price index (PPI) data from the ABS for Q3 of 2016 further confirm Australia s weak inflation environment, with price rises for final goods up by just 0.3% q/q and 0.5% p.a.. Price rises for preliminary demand (+0.6% q/q, +0.1% p.a.) and intermediate demand (+0.6% q/q, +0.2% p.a.) goods were stronger in Q3 (but somewhat more erratic over the year), confirming the recent narrative of compressed margins for businesses, which has been a recurring theme in Ai Group s monthly business surveys, the Australian PMI, Australian PSI and Australian PCI. Driving the price increases for final demand goods and services in Q3 were agricultural products (+8.3% q/q) and livestock prices (+11.9% q/q). Price increases for Intermediate demand goods and services were driven by utilities (+1.2% q/q) and livestock prices (+4.3% q/q). Price increases for Preliminary demand goods and services were driven also by utilities prices (+1.3% q/q) and livestock prices (+3.5% q/q). 5

6 Chart 4: Manufacturing key price inputs Importantly, prices for manufacturing inputs saw a significant 2% increase in the September quarter (but were -0.1% p.a.). This sharp increase confirms other sources of information on input pricing, including the Australian PMI. The lower Australian dollar (driving imported input costs up) and rising energy prices have been key sources of input price pressure in recent years for manufacturers. Among the local inputs for manufacturers, the PPI confirms that electricity prices have increased markedly again (+1.7% q/q, +3.7% p.a.) likely due to increases in wholesale prices. However, gas price pressures appear to have eased in the PPI data (-1.2% q/q, -1.9% p.a.). This is contradictory to what many manufacturers are experiencing. Indeed, the opposite appears to have happened. The pricing picture presented by the PPI is somewhat muddied by the inclusion of industrial gas manufacturing in manufacturing in the PPI data series. Gas production has been significant in the past two years and some large LNG export terminals have come online during this period. These LNG producers use a significant amount of gas as a production input, mainly for liquefaction and then export. LNG prices, which for the most part are linked to oil prices, have plummeted around about the same time as this increase in LNG production and exports. Therefore, it is possible that the input costs (in the form of own use gas) for these large LNG exporters have decreased significantly. With the huge production volumes involved in the LNG trains, gas as an input for these producers has possibly crowded out that of traditional manufacturers in these data. This could help to explain why gas prices appear to be heading lower in the PPI, in contrast to the known experience of manufacturing gas customers who have been facing elevated gas prices. 6

7 This week s data and events, 24 October 28 October 2016 Day Date Data/event Data period Latest Wed 26 Oct ABS consumer price index Sep (Q) +0.7% q/q; +1.3% p.a. Thu 27 Oct ABS international trade price indexes Sep (Q) Fri 28 Oct ABS producer price indexes Sep (Q) imports -5.1% p.a.; exports -5.4% p.a. Jun: final demand +0.1% q/q; +1.0% p.a. HIA new home sales Sep (M) +3.8% m/m M = monthly. Q = quarterly. H = half-yearly. A = annual. All data are seasonally adjusted unless otherwise noted. Next week s data and events, 31 October 4 November 2016 Day Date Data/event Data period due for release Previous release Mon 31 Oct RBA private sector credit Sep (M) Aug: +0.4% m/m; +5.8% p.a. Tue 1 Nov Ai Group Australian PMI Oct (M) Sep: 49.8 RBA board meeting and cash rate decision Nov (M) 1.50% cash rate Wed 2 Nov ABS building approvals Sep (M) Aug: -1.8% m/m; +10.1% p.a. Thu 3 Nov Ai Group Australian PSI Oct (M) Sep: 48.9 ABS monthly trade statistics Sep (M) Aug: exports $26.9bn imports $29.0bn Fri 4 Nov RBA Statement on Monetary Policy Oct (Q) ABS retail trade Sep (M) Aug: +0.4% m/m M = monthly. Q = quarterly. H = half-yearly. A = annual. All data are seasonally adjusted unless otherwise noted. 7

8 Australian economy: latest full-year estimates and government forecasts RBA (Aug 2016) actual actual f f f p GDP, % change p.a Inflation (CPI), % change p.a Treasury (May 2016) p GDP, % change p.a Household consumption, % p.a Dwelling investment, % p.a Business investment, % p.a Employment growth, % p.a Unemployment rate, % Terms of trade, % change p.a Inflation (CPI), % change p.a Wages (WPI), % change p.a Sources: ABS various data; RBA Statement on Monetary Policy; and Australian Treasury, Federal Budget f = forecast. p = projection. Australian economy: latest indicators Economy FX and commodity prices (as of Friday) RBA official cash rate, % Oct (M) AUD/USD exchange rate US$ Real GDP, % change p.a. Jun (Q) 3.3% Oil price (WTI light crude, USD/BBL) US$49.72 Headline CPI, % change p.a. Sep (Q) 1.3% Gold price (USD/OZ) US$1, Unemployment rate, % trend Sep (M) 5.6% Copper price (USD/tonne, LME spot) US$4, Australian Industry Group monthly indexes Australian PMI Australian PSI Sep (M) Sep (M) Australian PCI Sep (M) 51.4 M = monthly. Q = quarterly. All data are seasonally adjusted unless otherwise noted. Arrows represent direction of movement relative to last week for prices, and last observation for growth rates and indexes. Sources: ABS various data; Ai Group; Australian Financial Review market prices (as of Fri); London Metals Exchange market prices (as of Fri). Ai Group Economics and Research Team Julie Toth Chief Economist (03) David Richardson Senior Economist (02) Jesse Oliver Economist (03) Colleen Dowling Senior Research Analyst (03) Elle Spyropoulos Research Assistant (03)