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Yesterday’s CPI print for the first quarter was slightly above market expectations at +0.6% q/q for a 1.6% increase over the year (up from 1.3% in the previous quarter). However, the more closely watched, at least by the RBA, measure of ‘core’ inflation was up just 0.4% q/q with the annual rate falling to 1.4%. Average ‘core’ inflation is defined as the average of the trimmed mean and weighted median; two analytical series which exclude the upper and lower elements within the CPI basket.
As Justin Smirk at Wetspac has noted (see his note here), the effects of the depreciation of the Australian $ are having an upward effect on inflation. We can see that effect if we consider the Tradables and Non-tradables inflation data from the ABS. This shows Tradables inflation (those goods traded on the international market and therefore more impacted by moves in the A$) was up 1.2% q/q and up 1.1% for the year. Although this annual rate is well below the Non-tradables figure of 1.8%, it is the only reason that headline CPI has moved higher this quarter.
We should note that despite tradables prices showing a 1.2% jump in the quarter, this measure is NOT a core figure and therefore incorporates some highly volatile import goods (notable petrol) which have risen sharply and will have been excluded from ‘core’ measures.
Previous studies have suggested that a 1% shift in the value of the A$ equates to approximately a 0.03% move in core inflation. The graph below shows average core inflation plotted with adjusted core inflation (adjusted by an amount corresponding to the deviation of the A$/US$ rate from its 2 year moving average). What we see is that, were it nor for the deprectaion of the A$ below its 2 year average, core inflation would be even lower.
The next graph plots the deviation between the two. Readings above zero indicate that core inflation is being pushed higher by a generally weakening A$ (and its corresponding upward pressure on import prices) ,while readings below zero indicate that the A$ is stronger than its 2 year moving average and therefore suppressing core inflation. What we see is that the weakness seen in the A$ over previous quarters is adding about 0.2% to core inflation. Indeed over the past 5 years the effect of currency movements have been generally adding to core inflation but over that time core inflation has fairly consistently been falling.
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