Australia & New Zealand Weekly: Falling Electricity Prices is a Game Changer for Australian Inflation

Week beginning 30 July 2018

• Falling electricity prices is a game changer for Australian inflation.
• Australia: dwelling approvals, trade balance, retail sales, private credit, CoreLogic home value index.
• NZ: employment, wages, building consents, business confidence.
• China: NBS and Caixin PMIs.
• Europe: CPI, employment, GDP.
• US: FOMC policy decision, payrolls, PCE inflation, ISM surveys.
• Central banks: BOJ, BOE and RBI policy decisions.
• Key economic & financial forecasts.

Information contained in this report current as at 27 July 2018.

Falling Electricity Prices is a Game Changer for Australian Inflation

The June Quarter CPI printed 0.4%qtr compared to Westpac’s forecast for 0.4%. The market median was 0.5%. Given that at 2 decimal places the rise in the CPI was 0.36%qtr it’s clearly a soft update. The annual rate was lifted on base effects to 2.1%yr compared to 1.9% in 2018 Q1 and 2017 Q4 and 1.8%yr in Q3.

The core measures, which are seasonally adjusted and exclude extreme moves, rose much as expected (0.46%qtr vs our 0.50%qtr forecast). In the quarter, the trimmed mean gained 0.52% while the weighted median lifted 0.49%. Including revisions, the annual pace of the average of the core measures was 1.9%yr a moderation from the 2.0%yr pace in the previous three quarters.

The ABS analysis also confirmed the negative seasonality in the June quarter CPI with the seasonally adjusted estimate rising 0.5%qtr vs the 0.4%qtr headline print. It is curious then that the market had a 0.5% qtr median forecast for both the headline and core inflation. Unless there was something extreme in the distribution of price changes, then all else held equal, you would expect that the forecast for core inflation should be higher than your estimate of the headline inflation given that the components are seasonally adjusted before trimming. The fact that the market median headline estimate was equal to the core estimate suggests to us many analysts are making educated guesses for their forecasts and not completing bottom up component forecasts, then trimming the results, as Westpac does.

The six month annualised pace of core inflation is now 2.0%yr from 2.0%yr in Q1, and 1.7%yr in Q4 2017. For a broader core inflation measure, more in line with some international measures, market sector goods and services excluding volatile items rose 0.4%qtr holding the annual pace flat at 1.1%yr.

Key non-tradeable prices, particularly for housing, health and education, are restraining inflation, while energy prices have become an outright deflationary force. Outside of these factors however, there is no real evidence of a broadening in price disinflation/ deflation. For a more in depth review of the June Quarter CPI please refer to our bulletin Aust 2018 Q2 CPI: Waiting for Godot has a record run at the ABS.

Our interest is focused on housing costs, as where housing costs go, so too does non-traded inflation. Housing costs were close to our expectations rising 0.2% vs. 0.1% expected. However, the mix was very interesting with rents flat (0.2% expected), dwelling purchases rose 0.8% (vs. 0.5% expected) while the fall in utilities was greater than anticipated (–1.2% vs –0.9% expected). For utilities there was an expected fall in electricity bills (–1.3%qtr) and an even larger fall in gas & other household fuels (–2.2%qtr).

For rents, outside of the 0.8%qtr increase in Hobart, all other capital cities reported very soft or falling rents. Sydney and Melbourne reported gains of 0.3%qtr and 0.2%qtr respectively while rents fell –0.2%qtr in Brisbane and –1.8%qtr in Perth. Adelaide rents rose 0.4%qtr. Going forward it does appear there are downside risks to the very modest gains in rents we have in our inflation profile.

More significant to our inflation profile has been the shift in household energy bills. Up until this year, rising wholesale electricity and gas prices were driving household utilities costs higher. Then last year a policy shift by the Queensland Government and an unexpected surge in renewable power generation saw a collapse in wholesale electricity prices. Also the Federal Government’s intervention in the gas market last year to ensure more gas for domestic use helped to ease price pressures.

This is a game changer. Until recently we had expected that rising electricity prices would remain a meaningful inflationary pulse at least through 2018 and possibly into 2019. The recent fall in wholesale prices, which is likely to continue with the ongoing investment in renewables, plus Federal Government pressure via the release of a recent ACCC report into the National Electricity Market (ACCC releases blueprint to reduce electricity prices) we expect electricity prices to fall through 2018 and the first half of 2019. We have been conservative with the estimated decline and suggest the risks to our electricity inflation forecasts lie more to the downside than the upside.

The resulting impact of these changes is that we now forecast headline inflation to remain below 2.0%yr out to the end of 2019 (our forecast is for 1.7%yr at end 2019). That is correct; not only do we not expect inflation to return to the mid point of the target band but we don’t expect it to get back into the band.

But it is important to note that falling electricity prices are a key factor for dampening headline inflation. As to core inflation, we see it holding close to the bottom of the RBA’s target band through this period (2.1%yr at end 2019). As such, we think it is too early to start debating the risk of a rate cut by the RBA. RBA Governor Lowe has stated that in an environment of sound employment growth it was not in the interest of the welfare of the nation to lower interest rates further, as given such low embedded inflation, this may not generate the inflationary pulse via wages but rather just boost credit growth and further lift asset prices. (see RBA Governor, Philip Lowe, at the ECB Forum on Central Banking). The June Quarter CPI, and the revisions to our inflation forecasts are consistent with an RBA on hold out to the end of 2019.

Outside of utilities the other area where downside pressure appears to be significant was the smaller than expected seasonal re-pricing for household contents & services (0.3% vs 0.8% expected). It does appear that the competitive pressure to hold down prices in this sector continues so we are watching this space carefully. Our forecasts incorporate some pass through from a weaker AUD through the next two years. Any lack of such pass through presents a downside risk to both our headline and core inflation forecasts.

The week that was

Here and abroad, inflation was a key focus this week. In addition, for a change trade tensions eased as initial talks between the US and Europe were held. That said, the tense stand-off between the US and China remains.

For Australia, the June quarter CPI kept to a familiar theme as the headline series disappointed the market’s expectation for a seventh consecutive quarter. Headline and core inflation were both benign in the quarter at 0.4% and 0.5% respectively, with the weaker result for headline inflation coming as a result of June being a seasonally weak quarter (the core measures are seasonally adjusted and so abstract from this volatility). The annual rates also remain wedded to the bottom of the target band, at 2.1%yr and 1.9%yr respectively for headline and core inflation.

As it stands, the balance of risks imply that inflation is likely to hold around this pace through the remainder of 2018 and 2019. Key non-tradeable prices, particularly for housing, health and education, are restraining inflation, while energy prices have become an outright deflationary force. Outside of these factors however, there is no real evidence of a broadening in price disinflation/ deflation. As a result, inflation will not act as a catalyst to change the stance of policy.

While focused on Australia, it is also worth highlighting the recent release of the July Westpac Red Book, our in-depth assessment of the consumer. Key in this edition is the emerging tension between consumers’ increasingly positive view of the economy and still-circumspect attitudes towards family finances.

The surprise passing of the Government’s personal tax measures has clearly bolstered sentiment, albeit more so towards the broader economy than individuals’ finances. Arguably this speaks to cost of living pressures remaining front of mind, as well as angst that wealth is being eroded by house price declines, particularly in Sydney and Melbourne. To the current modest pace of consumption growth and the throttling back of residential investment, negative wealth effects and tighter lending standards are clear risks.

For the global economy, it was a relatively quiet week, with only two key events: a meeting between US President Trump and EC Commission President Juncker on trade; and the ECB’s July policy meeting.

For the market, the trade meeting achieved what was hoped: an easing of trade tensions through an agreement to discuss reducing trade barriers between the two global super powers. It will be some time before talks occur and detail is released; but for the moment, market sentiment will rest on a surer footing as long as a further escalation of tensions between the US and China does not eventuate. With this backdrop, the ECB met for their July meeting.

The guidance provided on policy was the same as at the June meeting. Notably, rates remaining on hold “through the summer” was confirmed to mean that the first rate hike would not be seen until after summer’s end. Ergo, the stance of policy in Europe will be unchanged until at least September or October 2019, with the exception of the end of asset purchases at December 2018 (which is already priced into markets).

To see a rate hike cycle start at that time, economic growth needs to remain broad based such that wage and income growth accelerates further, and inflation develops a robust foundation. From less than 1.0%yr at June 2018, core inflation has a long road to travel to be near (but below) 2.0%yr on a sustained basis as the ECB intend. Worth noting from the Q&A was: the ECB’s comfort with the Euro’s depreciation in 2018, which is seen as the result of the US’ outperformance on growth and policy; and yet another call for fiscal reform from President Draghi. The latter is certainly necessary if activity and job growth is to remain above trend in coming years.

Chart of the week: Australia CPI forecast errors

The June Quarter CPI printed 0.4%qtr compared to Westpac’s forecast for 0.4% and the market median of 0.5%.

We have now seen seven consecutive quarters where forecasters over-estimated the CPI print. The average error since the December quarter 2016 is +0.14ppt. Core inflation came in as expected and, as a group, analysts are broadly getting the core inflation pulse corrected (average error 0.02ppt over seven quarters) but continue to underestimate the disinflationary pulse hitting certain sectors leading to greater than usual discounting (or less than usual post sales repricing) in those sectors.

New Zealand: week ahead & data wrap

Over the past week we’ve seen more evidence that the economy slowed in the first half of the year. Notably, net migration has continued to slow and there are signs that firms are aren’t importing capital equipment at the same pace they were earlier in the year. Soft growth in recent months is also likely to mean that after a string of stronger reports, the labour market took a breather in the June quarter.

This week we had further confirmation that the economy shifted down a gear in the first half of the year. One thing we had been expecting was a lull in business investment on the back of policy uncertainty and weak business confidence over recent months. This view was supported by recent surveys where businesses reported that they intended to invest less over the coming months. However, until this week, we had little hard evidence of an actual decline in investment. This week’s merchandise trade data may be one of the first signs. The pace of capital equipment imports slowed in June, consistent with our forecasts of a temporary lull in business investment in the second half of the year. We expect to see further cooling in capital equipment imports evident in trade data in the coming months.

Another key element of the slowdown is lower net migration. June net migration data was again consistent with this view. Monthly net migration slowed further, taking annual net migration to its lowest point since November 2015. While this is still a historically high level, annual net migration has fallen from a peak of 72,500 to just below 65,000 now.

Much of the recent easing in net migration has been driven by changing trans-Tasman flows. The relative attractiveness of the Australian labour market has improved on the back of strong employment growth and a falling unemployment rate. We expect the relative attractiveness of labour market conditions to continue to move in Australia’s favour over the coming years. This is likely to lead to a growing number of New Zealanders once again heading to Australia to seek their fortunes across the ditch.

That said, local labour market conditions are currently uncertain. Presently, labour market conditions are very firm with the unemployment rate at a 9 year low and widespread angst amongst firms about the difficulty of finding workers. However, we expect the slowdown in broader economic conditions to ultimately impact on demand for labour – albeit with a lag. These competing tensions are likely to be evident in the suite of labour market data for the June quarter released next week.

On balance we expect the unemployment rate to hold steady at 4.4%. While labour market data can be notoriously choppy from quarter to quarter, the unemployment rate tends to be the most reliable measure of what’s truly going on. What’s more, some of the detail in next week’s release could be a little surprising for financial markets. Most notably we’re forecasting negative employment growth for the quarter. Much of this reflects our allowance for a distorted seasonal pattern in the survey rather than a genuine difference of opinion with other forecasters expecting positive employment growth. Nevertheless, such a seemingly weak result would likely generate some commentary and a reaction in financial markets. We emphasise focusing on the unemployment rate as the most reliable measure.

With inflation firmly back on the radar for both markets and the Reserve Bank in recent weeks, there will also be interest in how the various wage measures are evolving. To date there has been little evidence that the tightening labour market has led to a pickup in wage pressures. And our forecasts assume that this remains the case in the June quarter. Although we expect a 0.5% quarterly lift in the Labour Cost Index (LCI) (a step up from the string of 0.4% increases) the lift is mostly due to this year’s larger than usual minimum wage hike and last year’s aged care workers’ pay equity settlement. The LCI tends to evolve very slowly, so any deviation from our forecast – in either direction – would be noteworthy. Importantly, we don’t expect wage pressure will be contained indefinitely. Rising inflation expectations combined with a low unemployment rate and policy changes that have swung the dial in favour of employees in wage negotiations should see wage inflation eventually start to drift higher next year.

With the Reserve Bank’s dual employment and inflation mandate now firmly in place, next week’s labour market data will also form an important part of the deliberations ahead of the Monetary Policy Statement released on the 9th of August.

For the record, we think it’s extremely unlikely that any surprises in the labour market data will be enough to shift the Bank from its on hold “for some time to come” stance. While inflation pressures are rising, most notably with non-tradable inflation printing above the RBNZ’s forecasts in Q2, and measures of core inflation edging higher, rising inflation pressures are being largely offset by slower growth. GDP grew 0.4% in the March quarter, well short of the RBNZ’s 0.7% forecast while their 0.8% forecast for Q2 also looks too optimistic to us.

Given these broadly offsetting developments, the RBNZ is unlikely to be hurried into action any time soon. We maintain our view that it will be the final quarter of 2019 before the RBNZ raises the OCR.

Data Previews

Aus Jun dwelling approvals

• Jul 31, Last: –3.2%, WBC f/c: flat
• Mkt f/c: 1.0%, Range: -3.0% to 4.0%

Dwelling approvals fell 3.2% in May with a surprisingly sharp 8.6% fall in private detached houses partially offset by a 4.3% rise in units. With some wild swings in some of the state detail, we advise caution in interpreting the latest figures. In particular, a sharp fall in Qld may prove to be noise or a temporary pull-back. More generally, key parts of Westpac’s forecast for a further weakening in high rise construction have yet to come through.

The June update should resolve some of these questions. While the May drop looks overdone, construction-related housing finance approvals continue to point to a clear downtrend in non-high rise approvals. Meanwhile site purchases have for some time been pointing to a further sharp leg lower for high rise approvals. On balance we expect total approvals to hold flat in June even with some give back on the May weakness in houses. Risks abound including potential upward revisions to previous estimates.

Aus Jun private credit

• Jul 31, Last: 0.2%, WBC f/c: 0.3%
• Mkt f/c: 0.3%, Range: 0.3% to 0.4%

Private sector credit growth is modest and slowing as housing cools. In May, credit grew by only 0.2% and annual growth slipped to 4.8%, down from 5.4% last September. For June, we anticipate a rise of 0.3% and annual growth of 4.5%, the slowest pace since early 2014.

Housing credit, at this late stage of the cycle, is slowing as tighter lending conditions see new lending decline. In May, housing credit growth was 0.37%mth, 5.8%yr. The 3 month annualised pace has eased to 5.1% and is set to move lower.

Business credit, 3.8% above the level of a year ago, is volatile around a modest uptrend as businesses increase investment in the real economy. For May, it was a weak update, a -0.2%, after a 1.2% jump over the previous two months. We anticipate a small rise in June – but volatility means there is a degree of uncertainty around this figure.

Personal credit continues to contract, -1.3% over the year.

Aus Jul CoreLogic home value index

• Aug 1, Last: –0.3%, WBC f/c: –0.5%

Australia’s housing market continues to correct. Prices dipped 0.3% in June marking the ninth successive monthly decline. Prices nationally are down 2.2% from their Sep peak.

The correction remains both relatively shallow and narrowlybased, concentrated in the previously strong Sydney and Melbourne markets. These two markets have now seen no net gain in prices since late 2016 and mid-2017 respectively. The Perth market remains stuck in its long running correction as well.

The daily index suggests price slippage quickened again in July with a 0.5% decline that will mean prices are down –2.5%yr nationally. Auction clearance rates weakened notably through May-June-July, pointing to an additional drag from tightening loan criteria and longer approval processing times.

Aus Jun trade balance, AUDbn

• Aug 2, Last: 0.8, WBC f/c: 1.1
• Mkt f/c: 0.9, Range: 0.2 to 1.6

Australia’s monthly trade account has been in surplus so far in 2018. For June, we anticipate another trade surplus, widening a little to $1.1bn, up from $0.8bn in May.

The import bill is expected to be broadly unchanged, with a lift in volumes potentially offset by a modest pull-back in fuel prices (following sharp rises of late).

Export earnings are expected to expand by 0.8%, $0.3bn, boosted by a lift in coal volumes and higher coal prices. Fuels (including LNG) and metal ores (including iron ore) are expected to be little changed with modest gains in volumes offset by lower prices.

The average monthly trade surplus for Q2 would be $0.8bn (subject to revisions), narrowing from $1.2bn for Q1. This modest deterioration likely reflects the impact of a decline in the terms of trade, down an estimated -1½%.

Aus Jun retail trade

• Aug 3, Last: 0.4%, WBC f/c: 0.3%
• Mkt f/c: 0.3%, Range: 0.1% to 0.7%

Retailers reported a slightly better than expected, though still modest, 0.4% lift in sales in May. A rebound in clothing and department stores drove the gain with weak conditions across other categories. Some of the rebound is likely weather-related after abnormally warm conditions weighed on clothing sales in the early part of winter. Retail ex clothing and department stores was flat in the month.

Indicators suggest retailers continued to see mixed conditions in June. Consumer sentiment lifted following the tax cuts announced in the May Budget but key spendingrelated components remained soft. Private business surveys were mixed, retail responses to the NAB survey softening but the AiG survey showing an improvement. On balance, we expect May to show a 0.3% gain. Note that price discounting pressures are easing a touch and may ease further with GST changes on July 1 that mean low value imported goods will now be taxed.

Aus Q2 real retail sales

• Aug 3, Last: 0.2%, WBC f/c: 0.8%
• Mkt f/c: 0.8%, Range: 0.4% to 1.0%

Q1 was a weak quarter for consumers with real retail sales rising just 0.2%. The main surprise was around retail prices which rose 0.4%, accounting for most of the nominal gain in sales over the quarter. The price lift was mainly driven by food with price deflation continuing across non food categories. Notably the detail showed weaker quarter to quarter volumes across almost all non-food categories as well.

The disappointing Q1 result follows a choppy run, the previous four quarters showing gains of 0.2%, 1.4%, 0.2% and 0.8%. Some of this may be due to shifts in the timing of sales, particularly around the Christmas-New Year period.

The Q2 update is likely to show a rebound. Nominal sales are on track to be up 1.0% vs 0.6% in Q1. The Q2 CPI detail suggests retail prices rose about 0.2% in the quarter – this time with weakness in food offsetting firmer non-food prices. While uncertain, the mix points to a 0.8% rise in real sales.

NZ Jun residential building consents

• Jul 31, Last: +7.1%, WBC f/c: -12%

Residential consent issuance surged higher in May, rising by 7.1%. That took consent numbers to their highest level since 2004. In part, this pickup was due to some ‘lumpy’ changes, including a roughly 25% increase in the usually stable standalone homes category in Auckland last month. More importantly, there has been a sizeable trend increase in medium density consents in Auckland, supported by regulatory changes.

Consent numbers in most other regions remain firm, though issuance in Canterbury is gradually easing back.

With some ‘lumpy’ issuance in recent months, we expect to see a sizeable pullback in overall consent numbers in June. However, the level of issuance is still expected to remain elevated, supported by continued high numbers of consents for medium density homes in Auckland.

NZ Jun ANZ business confidence

• Jul 31, Last: -39

Business confidence weakened further in June and firms’ expectations of their own activity fell to its lowest level since November 2017.

The fall in business confidence was relatively widespread. However, there was some improvement in confidence in the agricultural sector in June following the Government’s announcement of its intention to attempt eradication of Mycoplasma bovis and a strong opening payout forecast from Fonterra. Since then dairy prices have fallen sharply which may dent confidence.

Inflation expectations edged higher in June and could go further in the coming months on the back of rising petrol prices and higher headline inflation.

NZ Q2 Household Labour Force Survey

• Aug 1 Employment, Last: +0.6%, WBC f/c: -0.3%, Mkt f/c: +0.4%
• Aug 1 Unemployment Last: 4.5%, WBC f/c: 4.4%, Mkt f/c: 4.4%

New Zealand’s labour market has tightened over recent years. But slowing economic growth is likely to put a dampener on the pace of improvement.

We expect the unemployment rate to hold steady at 4.4% in the June quarter, ending a five-quarter run of declines. This is in line with the Reserve Bank’s forecast and other market forecasts.

Where we differ is in our forecast of a drop in employment for the quarter. That largely reflects our allowance for a distorted seasonal pattern in the survey. Nevertheless, such a seemingly weak result would likely generate some reaction in the market. We recommend focusing on the unemployment rate as the most reliable measure of labour market trends.

NZ Q2 Labour Cost Index

• Aug 1, Private sector Last: 0.4%, WBC f/c: 0.5%, Mkt f/c: 0.6%

The Labour Cost Index is a very slow-moving measure of wage growth. Recent years have seen a string of 0.4% quarterly gains, aside from the aged-care workers’ pay equity settlement in Q3 last year.

We expect a slightly larger 0.5% increase for the June quarter. The main factor is the 4.8% minimum wage hike this year, compared to average increases of 3.4% in the last few years. That aside, we don’t expect to see widespread evidence of a pickup in wage growth yet.

In contrast, the Quarterly Employment Survey (QES) measure of average hourly earnings has accelerated in the last year, and we expect a further pickup this time. But this measure slowed sharply a year ago, and it’s not clear whether this rebound will be sustained

UK Bank of England Bank Rate

• Aug 2, Last: 0.5%, WBC f/c: 0.5%, Mkt f/c: 0.75%

The Bank of England’s August decision is looking finely balanced. The BOE has previously signalled a gradual modest tightening will be required over the next few years. And since their previous decision, we’ve seen the unemployment rate remain low and a number of indicators have pointed to a firming in growth through the middle part of the year.

However, the pace of growth remains muted. In addition, inflation has been easing back, with the core rate now down to 1.9%. On top of those factors, the political backdrop remains rocky, with Brexit casting a long shadow over the economy’s longer-term outlook.

Given the lingering downside risks, we expect that the Bank of England will keep the Bank Rate on hold at its August meeting, and that they will maintain a gradual tightening bias.

US FOMC Aug policy meeting

• Aug 1, Last: 1.875%, WBC f/c: 1.875%

The recent run of data has been with confidence and the FOMC. While they are very unlikely to upset the apple cart by accelerating the pace of fed fund rate hikes, the view put forward for the economy after the Aug 1 meeting will be very constructive.

Evident in recent communications has been strong confidence in the labour market and hence household consumption. Meanwhile in the business sector, though recent trade tensions have fostered risks, broadly the Committee continues to believe that investment will add to growth through this year and next.

Also apparent is that Chair Powell and the rest of the FOMC are not (yet) concerned about what the yield curve may be signalling, or financial conditions more broadly. The latter will bite, but not until mid-2019 after four more hikes.

US Jul employment report

• Aug 3 Employment change, Last: 213k, WBC f/c: 180k
• Aug 3 Unemployment rate, Last: 4.0%, WBC f/c: 3.9%

The US labour market has continued to exceed expectations in 2018. Employment growth continues to run well ahead of the pace needed to hold the unemployment rate constant. And, as a result, all measures of labour market slack have continued to move lower, past historically low levels.

Come July, we look for another strong result, albeit a little more modest than those seen of late. A 180k gain would still see the average pace of 2018-to-date remain above that of 2017, and would further build the case for stronger wage gains.

On that point, it is worth noting that the June data for personal income and the employment cost index on 31 July will precede the July employment report. Both are worthy of close attention.