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TD: AU: Rising March Quarter Producer Prices: A Sign Of Inflation To Come, But Not Next Week - 21 April 2011

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Fuseworks Media
Fuseworks Media
TD: AU: Rising March Quarter Producer Prices: A Sign Of Inflation To Come, But Not Next Week - 21 April 2011

TD Securities

Going for gold (and other commodities)

March quarter Producer Price Index

 1Q 2011 domestic final producer prices (received by producers for finished goods) increased by 1.2%Q/Q or 2.9%Y/Y, better than expectations for 1% and 2.7% respectively.

 Intermediate and preliminary (input) price indexes increased by 2.3%Q/Q, 4.4%Y/Y and 2.6%Q/Q, 5.5%Y/Y respectively.

 At every stage of production, the index was pushed higher by energy-related and agricultural commodities prices.

 Imported preliminary prices (mostly energy) increased 3.9%Q/Q, while domestic prices increased a lesser 2.4%.

 On the other hand, the benefits of a rising AUD can be seen in prices paid to overseas suppliers of final goods, with imported final goods prices falling 0.3%Q/Q while domestic prices increased 1.4%.

TD view for markets

 We are now back to a pricing structure we last saw in 2008 at the height of 'resources boom Mark I' (to use the Treasurer's parlance) where preliminary input prices were growing much faster than output prices; and imported energy prices were rising much faster than domestic prices but other imported goods prices were rising by less.

 The difference is that in 2008, consumer price inflation was also very high, peaking in September 2008 (after the financial crisis brought demand growth sharply lower) at 5%Y/Y. Even the underlying measure topped out that quarter at 4.8%. At the same time, the RBA Cash Rate peaked at 7.25%.

Pipeline price pressure, not consumer price pressure

 Today's data reinforce our view that the same pipeline price pressures exist as did pre-financial crisis, particularly due to the strength of prices rises across the commodities complex. However, those pressures are yet to translate into a strong rise in consumer prices.

 Weak consumer demand is the only thing keeping the lid on consumer inflation, which has bottomed out but is now starting to creep up.

 The low starting point means that underlying inflation is still likely to be hovering around the lower end of the RBA's 2-3% band.

CPI preview

Strong rises in both the import price index and PPI earlier this week have set the tone for the March quarter CPI. We are probably past the weakest point for inflation but it is still headline and not underlying inflation that is doing the heavy lifting so far.

It's a theme echoed around the world, it's driven by ultra-loose monetary policy settings in most of the developed world (although not in Australia), and it is manifest in historically-high commodities prices.

The March quarter import price index increased 1.4%Q/Q, stronger than the 0.9% anticipated and a big rebound from -3.8% prior. A 13.4%Q/Q rise in mineral fuels import prices accounted for the vast bulk of the uptick. Today's PPI print reflected this same trend.

Headline inflation increased 0.4%Q/Q or 2.8%Y/Y in the December quarter and is expected to accelerate to 1.0%M/M and 2.8%Y/Y on the sharp rise in fuel prices, plus some contribution from higher food prices.

We are a little below consensus which sees the headline CPI rising 1.2%M/M to be 3.0%Y/Y higher, but we have been guided by our proprietary monthly Inflation Gauge.

According to the Gauge, through February and March Australia experienced outsized price rises for fruit and vegetables, automotive fuel, and alcohol and tobacco. Due to an ongoing lack of supply as a result of floods in Queensland and cyclone Yasi, the price of fruit and vegetables rose by 11.3% in March alone, following a 5.1% rise in February. Consistent with rising oil prices on enhanced geopolitical risk, the price of automotive fuel rose by 5.3% in March, building on the 1.6% rise in February.

Anecdotal evidence suggests we will also see contributions to headline inflation from utilities prices as well as the normal seasonal increases in childcare and education costs.

A look at recent inflation prints from the dollar-bloc doesn't give much guidance to what is in store for Australia next week. In New Zealand, headline inflation was 0.8%Q/Q, weaker than the 1.0% forecast. But in Canada, headline was 1.1%M/M, much stronger than 0.6% forecast; and core inflation was an even more worrying 0.7%M/M when just 0.2% was expected.

The relatively stronger Canadian print cannot be explained by relative currency moves either. CAD appreciated by 6% over the six months to March 31 whereas NZD was 'just' 3.7% stronger. Not what one might expect.

AUD has outperformed both its dollar-bloc peers over this period, rising 6.8%; but clearly this is not a reliable indicator that the inflation print will necessarily be soft.

What matters most

What matters for the RBA and monetary policy of course are the RBA's own underlying CPI measures. Based on guidance from the Inflation Gauge we see core inflation rising by 0.5%M/M or 1.9%Y/Y while consensus is again a touch higher at 0.7%M/M and 2.1%Y/Y.

In the December quarter, core inflation (trimmed mean and weighted median) increased 0.4%/qtr on average, lowering the annual growth rate from 2.5%/yr to 2.3%/yr.

If core CPI prints somewhere close to these forecasts, it will be around the lower bound of the RBA's 2-3% target and provide no reason to worry that the monetary policy risks slipping behind the curve should it remain on hold for longer.

While underlying inflation appears contained for now, we remain of the view that inflation pressures are set to accelerate into 2012, as a lagged response to the boom in national income, accelerating wages growth and the rebuilding efforts in the wake of Australia's own natural disasters. However, we are mindful that this pickup in inflation is taking a lot longer to materialize than we expected.

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