Australian inflation surprised on the upside again in May due to services prices

26/06/2024 15:31:00

• Australia’s Monthly Inflation indicator rose by 4% over the year to May, higher than the 3.8% expected by economists. Annual inflation has ticked up every month since March and is now at the highest pace in the past 6 months.
• The monthly CPI indicator tends to be noisier than the official CPI and does not provide a comprehensive look at Australian inflation, because not every category is surveyed every month. Therefore the implied monthly change (-0.1%) is less meaningful. Nevertheless, this May report is important because includes the most categories for the quarter (~2/3 of the CPI basket), and in particular it contains many services items. Service prices are more persistent and are the main concern for the Reserve Bank at the moment.
• The upside surprise in the monthly inflation data in the past three months is a warning for the bumpy path of the disinflation process, especially as services inflation seems to be picking up.
• As a result of the May inflation data the risk of another hike in August is now around 45%, with June quarter inflation data due in a month key.

Source: ABS, AMP

• Underlying inflation pressures measured in the monthly CPI report have trended slightly up this year. Excluding volatile items & travels, annual CPI only ticked down slightly to 4%yoy from 4.1% last month; while the trimmed mean ticked up for the fourth consecutive month to 4.4% (from 4.1%).

Source: ABS, AMP

• While Monthly inflation has slowed from its peak of 8.4% year on year in December 2022, the progress in reducing inflation has stalled in recent months mostly stemming from services (yellow bars in the chart below). Notably,

1. Rents increased by 7.1%yoy reflecting the very tight rental market with low supply versus high demand. The monthly pace has picked up to 0.8%mom (from 0.5% last month).
2. Electricity prices rose 6.5% over the last 12 months (from 4.2% in April), reflecting the unwinding of the Energy Bill rebates since July last year.
3. Insurance & financial service costs are being adjusted upwards with some lag, rising 7.8% over the year.
4. Holiday travel prices clocked the first annual rise since October, rising 2.9%yoy due to rising international holiday prices.
5. Even rises in streaming service charges are showing up in a 6.5% rise over the year in audio, visual and media services.

• Goods disinflation has also stalled lately. New dwelling purchases inflation was unchanged at 4.9%, reflecting builders passing on higher costs for labour and materials to customers. Commodity wholesale prices have been rising year to date, leading to a 9.3% annual increase in automotive fuel (despite a monthly fall in May). Fruit & vegetables were also a major upside surprise in May, increasing at the fastest pace in a year (+4.4%yoy) due to more expensive grapes, strawberries, blueberries, tomatoes, and capsicum.

Source: ABS, AMP

• The worrying takeaway from the May CPI report is that some large rises that occurred in April did not slow or reverse as previously hoped. Insurance rose 3% just in a quarter, rents picked up pace again despite recent moderation in asking rents, and hairdressing, media services, and vehicle repairs also remained high.

• The monthly CPI indicates that the quarterly headline CPI is on track for a 3.8%yoy increase in line with the RBA’s forecast. The concern though is that the rising trend in the monthly trimmed mean points to a June quarter increase in the trimmed mean well above the RBA’s forecast for a 3.8%yoy rise. As a result, the risk for another rate hike from the RBA has gone up materially to around 45%. June quarter inflation in a month will be key.

• That said, the RBA needs to be cautious here as monetary policy is judged by the RBA itself to be “restrictive” and is working to slow the economy, the lagged effect of past hikes is yet to fully show up, growth has slowed to a crawl and households are under pressure that will only be partly relieved by tax cuts from next month. As such the risk of overdoing the rate hikes is high adding to the risk of recession.

• So as Governor Bullock noted, the “narrow path” of doing too much and ending up in recession and doing too little and locking in high inflation appears to be narrowing.

• Our base case remains that rates have peaked but the risk of another hike is high and we have pushed out the first cut to February next year.

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