The Reserve Bank uses three measures to get a handle on the ‘underlying’ measure of inflation. Two are so-called ‘statistical’ measures – the weighted median and trimmed mean. The third measure is the CPI less fruit, vegetables, petrol and deposit and loan facilities (CPIX). Many analysts think that the Reserve Bank only uses the statistical measures, but the three measures are highlighted in every quarterly statement.
Of course, it is important that the Reserve Bank does use a range of techniques to gauge the ‘true’ level of inflationary pressures. At any point in time there is a raft of influences pushing and pulling on the inflation outcome. Petrol prices are affected by the vagaries of the Aussie dollar and global crude oil markets. Food prices are affected by drought, flood, changes in government policies and world commodity prices. Financial services prices can be affected by interest rate decisions. And housing prices and rents are influenced by demographics, immigration and government policies.
The Reserve Bank is effectively trying to abstract from the ‘noise’ and work out how the pace of economic activity is affecting inflationary pressures. If the economy is strong and there are plenty of dollars chasing the limited amount of goods then there will be upward pressure on prices. And clearly that will send a signal to the Reserve Bank to lift rates and slow the economy down.
In the December quarter the weighted median rose by 0.7%, the trimmed mean rose 0.6% and CPIX rose by 0.5%. The average increase of 0.6% was the lowest result in three years. The annual rates of inflation also eased with the average of the three measures falling to 3.36% – in line with the Reserve Bank’s 3¼% estimate.
Overall the results still give the impression that ‘underlying’ inflation is above the Reserve Bank’s target band – although it is easing in line with the Reserve Bank’s target. The question though is whether the measures chosen to track underlying inflation are doing a good job. The problem is that the statistical measures have consistently printed above other ‘underlying’ inflation measures for the past seven years.
The Bureau of Statistics has a measure called market goods and services less volatile items (MGSX). Not only has there been a persistent gap between the statistical measures and MGSX in recent years, that gap now stands at a record (22-year) high. The worry is that if the statistical measures are giving false readings of the true, or underlying, state of inflation, then it could lead to policy errors.
Still, it’s important to note that the inflation target is still expressed in terms of CPI inflation. Whether viewed over the last three years, five years or 10 years, inflation has remained in the 2-3% target band.
The week ahead
For many, the year effectively starts in the coming week. Holidays are over, schools are back and Christmas/New Year is a distant memory. Certainly the Reserve Bank gets back to business this week, holding its first Board meeting on Tuesday. And a Melbourne Cup field of economic data is released.
Some analysts believe that another rate increase is a lay-down misere, but as News Limited’s Terry McCrann rightfully points out, that is far from the case. While interest rates remain low, the Reserve Bank has already lifted interest rates three months in a row at a time when almost every other central bank is still sitting on their hands. Certainly our economy is in far better shape than most but the IMF is continuing to warn of the dangers of removing stimulus too quickly.
The Reserve Bank certainly has a lot of mixed information to weigh up. While economic data has been encouraging, the first home owners boost and small business tax break are no longer propping up activity. The inflation data was good, not great. And while emerging economies are lifting, advanced nations are struggling.
On balance we expect the Reserve Bank to lift rates by another quarter of a percent on Tuesday. If the RBA Board opts to leave rates alone, it will be merely seeking to gather more information before continuing the process of ‘normalising’ rates.
In terms of economic data, the Bureau of Statistics will release data on house prices on Monday, but more accurate private sector figures have already been released. The Performance of Manufacturing gauge, new home sales, ANZ job advertisements and the TD Securities monthly inflation gauge are released the same day. And on Tuesday the NAB business survey for December is issued.
On Wednesday, data on wealth, international trade, retail prices and the Performance of Services index are issued. Retail trade and building approvals are slated for Thursday while the Reserve Bank releases its Statement on Monetary Policy on Friday. We expect that retail trade fell 0.5% in December after the out-sized 1.4% increase in November. And building approvals probably rose 2%, lifted by first home buyer activity.
In the US, it is that time of the month when employment or non-farm payrolls data dominate investor attention. The January figures are released on Friday and analysts are looking for a small rise in jobs of around 20-30,000. The labour market has clearly stabilised but businesses are still wary about putting on new staff.
Other data to watch over the week in the US include personal income, construction spending and the ISM manufacturing gauge on Monday. On Tuesday, pending home sales and car sales figures are issued. The ADP employment index is released on Wednesday together with the ISM services index. And factory orders and productivity estimates are released on Thursday.
Sharemarket
The Australian profit reporting season moves into first gear in the coming week with a handful of ASX 200 companies to issue results. Hills Industries and News Corp release interim earnings on Wednesday with Tabcorp to report on Thursday and Resmed to issue results on Friday.
The tight links between the Australian and US sharemarkets broke down in November last year and have shown few signs of moving back into synch. Over the past year the measure of correlation between the All Ordinaries index and the US Dow Jones was 0.96 (where perfect correlation equals 1.0). But over the past four months that correlation ratio stood at just 0.32. Encouragingly investors are increasingly looking in their own backyards again.
Interest rates, currencies & commodities
Since late last year, financial market participants have gradually shortened the odds of another rate hike in February. In late December a fourth straight rate hike was considered a 40% chance. Then after solid readings for employment and retail trade the odds were pushed up to 75%. And the odds have since held between 60-75%. Overall those estimates seem right. A rate hike is no certainty, but there is a good chance that the Reserve Bank will continue the process of ‘normalisation.’
Our agricultural commodity strategist Luke Mathews has just updated his views for 2010. He believes that the long-term fundamental picture is supportive for agricultural commodity prices, with rapidly expanding demand needing to be satisfied from a constrained resource base.
But the near-term outlook is mixed. Big grain and oilseed crops have helped alleviate stock tightness and are likely to weigh on prices, particularly for wheat and soybeans. Sugar prices are also likely to moderate from record highs in the second half of the year as the global supply response kicks into gear.
But the outlook is more positive for cotton. CBA says that global cotton prices should find support in 2010 due to tight supplies and the recovery in apparel demand. Currently cotton prices are near US69c a pound. But CBA expects prices to average US76c in the June quarter and US80c in the second half. Despite an assumed increase in global cotton plantings in 2010, CBA says that the increase in area will be insufficient to prevent the global stock to use ratio falling again. The last time the cotton stocks to use ratio fell near 45% was 2003/04, and in that period prices rallied to US85c/lb. Prior to that, in 1994/95 stocks fell below 40% with prices surging to US120c/lb.
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