Inflation is higher. But is it 'materially' higher?

That's the big question

Pendal

October 2023

AUSTRALIA'S latest inflation data was higher than expected.

The September quarter inflation number came out at 1.2% for both headline and underlying (trimmed mean) measures. This was above expectations of 1.1% and 1% respectively.

In terms of headline inflation, it's now fair to say the current pace is about 4% annually.

Last quarter it was 0.8%, dragged 0.2% lower by fuel prices. This quarter was 1.2%, dragged 0.2% higher by fuel.

The increase in underlying inflation would be of greater concern for the Reserve Bank.

A quarterly rate of 1.2% would not have been welcomed.

Under the hood

Looking under the hood would add to the RBA's concerns.

Market services remain stubbornly high. Housing inflation remains at over 2% a quarter, driven in part by utilities.

At least rents have now caught up with leading indicators at 8% annually.

Anyone who recently received their council rates will not be surprised by the 4.4% increase there. At least it only happens annually.

Government subsidies once again had an impact.

The government is already suppressing utility prices and now also childcare prices - though the childcare changes are permanent. Childcare costs were down 13%, subtracting 0.1% from this quarter's CPI.

Here you can see a breakdown of the ABS's latest inflation data:

What's material?

Focus now turns to the RBA's November 7 board meeting.

We have two communications recent communications to consider.

The RBA's latest minutes mentioned a "low tolerance" to upside inflation surprises.

And in her maiden governor speech, Michelle Bullock mentioned "the board will not hesitate to raise the cash rate further if there is a material revision to the outlook for inflation".

The question is - what is material?  

In August the RBA forecast year-end inflation to be 4.1% and 3.9% underlying. It's early days, but Q4 is expected to be around 0.9%.

This would leave headline at 4.3% and underlying at 4.1%.

The RBA will release updated forecasts in its next monetary policy statement on Friday November 10 (though it will reference them in their rate decision beforehand).

Is 0.2% higher "material" or a breach of the "low tolerance"? That will be the big question come November 7.

Markets have 60% chance of a hike in November and a cash rate 0.35% higher by early next year.

At these levels there is no clear trade, since it will be line ball.

If pushed, I think Michelle Bullock will be keen to show her inflation fighting credentials by putting in one hike, even though she was probably hoping today's number would let her off the hook.

If the market gets close to pricing two hikes in the next few weeks we will go long duration. But until then today's reaction seems sensible and fair.

Long bond yields largely ignored Wednesday's moves. Ten-year bonds remain around 4.75%.  

As always, they will rightly or wrongly be more captive to US bond moves and the latest iteration of oil prices.

Author: Tim Hext, Portfolio Manager and Head of Government Bond Strategies

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