Wednesday, October 26, 2016

Lineball call for Reserve as underlying inflation sinks

Weaker than expected underlying inflation has two market economists predicting a rate cut on Melbourne Cup Tuesday – although neither with much conviction.

Each of the Reserve Bank of Australia's preferred measures of underlying inflation slipped in the September quarter. The so-called trimmed mean came in at 0.4 per cent, down from 0.5 per cent in June.

The weighted median came in at 0.3 per cent, down from 0.4 per cent. The annual underlying rate averaged 1.5 per cent, well below the bank's target band of 2 to 3 per cent.

Although the headline rate climbed from 0.4 per cent for the quarter to 0.7 per cent and from 1 per cent over the year to 1.3 per cent, most of the jump was due to outsized increases in the price of fruit (up 19.5 per cent in the quarter) and vegetables (5.9 per cent) with tomatoes, potatoes, cucumbers, grapes, peaches, plums, bananas and mangoes the biggest movers.

"Our view before today's numbers was that an underlying increase of 0.3 per cent or less would leave inflation trapped at the very low rates that contributed to the May and August rate cuts," said Commonwealth Bank chief economist Michael Blythe.

"As such we continue to expect the bank to cut the cash rate to 1.25 per cent at the November meeting, although we hold this view without great conviction."

'Strong case'

Bank of Melbourne chief economist Besa Deda said persistently low inflation and further signs of slack in the labour market made a "strong case" for a further cut.

"That said, the data may not be enough of a downside shock for the bank," she said. "With some hesitation, we continue to expect the bank to cut official interest rates by 0.25 points when it meets next week, but we admit it will be a very close call."

Tradables inflation, which measures changes in the prices of goods and services that can be traded internationally, climbed from zero per cent in the year to June to 0.7 per netcent in the year to September. Non-tradables inflation, watched more closely by the bank, remained little changed in the year to September at 1.7 per cent, up from 1.6 per cent.

HSBC chief economist Paul Bloxham said the results left the door open for the new Reserve Bank governor Philip Lowe to cut rates if he wanted to.

"However, with growth running above trend, the central bank having cut by 0.50 points since May this year and coal and iron ore prices having bounced, I expect the bank to stay on hold."

Futures market trading ascribed a mere 0.6 per cent probability to a rate cut on Tuesday. The Melbourne Cup day board meeting will be followed by the release of updated Reserve Bank forecasts on Friday.

In The Age and Sydney Morning Herald