Inflation momentum in Australia gradually picking up

Consumer price data for the third quarter is expected to point to a gradual increase in price pressures, though at this stage there is in the view little risk of underlying inflation breaking out of the RBA's target band of 2-3%. Several factors point to an increase in the headline and core inflation rates, which are expected to overwhelm the impact of slightly weaker energy prices. Based on weekly private sector data in Q3 average petrol prices were down 0.7% qoq after a 12% rebound in Q2, so it is more a matter of absence of a boost rather than a substantial drag on the CPI. 

A sizable impact on annual inflation rates will come from the repeal of the carbon tax in July 2014, which will drop out of the year-on-year rate and add around 0.4pp to the headline rate. Furthermore, the trade-weighted exchange rate slid another 4.4% in Q3 from the previous quarter, to be 14% down yoy, marking the most rapid annual decline in the past few years. This is likely to increasingly pass into retail prices, especially household goods, automobiles and the like. At the same time, some sources of domestic price pressures also look set to have strengthened: house price inflation probably increased further in Q3 which directly feeds into housing costs, and unit labour costs growth also rose in Q2, albeit from very weak levels, which may begin to add to domestic price pressures. 

A 12.5% hike in the tobacco excise rate on 1 September will also have had an inflation-boosting effect, although given its timing the impact will be more visible in the Q4 rather than Q3 figures. Lastly, in Q2 there was a plunge in the cost of recreation (-1.4% qoq), driven by very large declines in holiday travel and accommodation (-3.5% qoq), both domestic (-5.4%) and international (-1.3%). Cheaper airfares owing to cheap oil can perhaps explain part of this, but the decline in the exchange rate should boost the cost of both international as well as domestic holidaying. Therefore some rebound is expected here. 

Because of the swings in energy prices the seasonally adjusted index is expected to have risen 0.5% qoq after 0.8% in Q2, but given a positive seasonal factor in Q3 a 0.8% qoq gain is expected in unadjusted terms, after 0.7% in Q2. This would lift the headline inflation rate by 0.4pp to 1.9%, so still just below the official target range. Core measures are expected to have risen a little more quickly than in Q2, by an average of 2.5% yoy after 2.3% in Q2 (0.6% qoq). From the RBA's perspective, such a set of data would be neutral for policy: underlying inflation would be in the middle of the target in both year-on-year as well as quarterly annualised terms - in other words, not a reason to adjust policy, but also not an obstacle for a move in either direction. Meanwhile, headline inflation will move fully back into the target range as energyrelated base effects reverse.