Australia's inflation to accelerate as A$ pass-through finally arrives

In an environment where domestic demand is relatively modest, non-tradable inflation is expected to remain well in check. Wages growth will be unlikely to accelerate from a 2.0-2.5% yoy range as spare capacity in terms of both heads and hours is only slowly absorbed. But it is unlikely to decelerate any further either, as the unemployment rate will likely only edge higher capped by growth in employment. 

The strength of the labor market, given weak activity, has been the surprising story of 2015, and this will continue to 2016. This is as the lower A$ fosters growth in labor-intensive services sectors that are in the main less capital intensive (and this has weighed on GDP). 

The lower Australian dollar, which will reach US$0.65 by the end of 2016, will be the key driver of inflation. Pass-through so far has been relatively modest, but pressures on retailers will continue as they try to reclaim costs incurred, as the AUD has tumbled from parity with the USD since 2013.