Bulletin

19 July 2013

Aust. Q2 CPI forecast 0.5%qtr, core 0.5%qtr. Disinflationary pressure remains particularly for discretionary goods and services.
The March quarter CPI surprised the market and
ourselves with a very modest 0.4%qtr rise. Weakness in food, household goods, motor vehicles, audio visual and holidays outweighed the normal seasonal positives and an outsized gain in dwelling costs.

June quarter 2013 CPI forecast

Q2 2013 forecast Item Food of which, fruit & vegetables Alcohol & tobacco of which, Tobacco Clothing & footwear Housing of which, Rents of which, House purchases of which, Utilities H/hold contents & services Health of which, Pharmaceuticals Transportation of which , car prices of which, auto fuel Communication Recreation of which, audio vis & comp of which, holiday travel Education Financial & insurance services CPI: All groups CPI: All groups % year % qtr 1.3 5.2 0.8 1.7 1.8 0.4 0.8 0.5 -0.4 1.6 1.6 -1.2 -0.6 -0.9 -2.0 0.2 -1.2 -2.6 -2.2 0.0 0.7 0.47 2.48 %qtr Core inflation Jun-13 0.60 0.39 0.50 0.57 0.53 0.5 -0.4 0.4 contrib 0.21 0.15 0.06 0.04 0.07 0.10 0.05 0.04 -0.01 0.14 0.08 -0.01 -0.07 -0.03 -0.07 0.01 -0.16 -0.07 -0.10 0.00 0.03 %qtr Mar-13 0.10 0.15 0.49 0.29 0.39 0.3 0.6 1.3 Q1 2012 actual % qtr -0.8 -5.4 1.6 3.7 -3.9 1.2 0.8 1.7 1.4 -1.3 3.0 7.6 0.5 -1.3 1.2 0.0 -0.8 -2.6 -1.8 5.7 0.7 0.39 2.50 %yr Jun-13 2.4 1.5 2.4 2.2 2.3 1.8 -0.4 4.2 contrib -0.13 -0.16 0.11 0.09 -0.15 0.28 0.05 0.15 0.05 -0.12 0.16 0.09 0.06 -0.04 0.04 0.00 -0.10 -0.07 -0.08 0.18 0.03 %yr Mar-13 2.5 1.5 2.6 2.2 2.4 1.9 -1.2 4.2

Our Q2 forecast of 0.5%qtr/2.5%yr is based on the usual

seasonal softness in electricity and pharmaceuticals. But just as critical is the fall in fuel and a moderation in new dwelling price inflation which are partly offsetting the seasonally unusual rise in fruit & vegetables. The seasonally adjusted CPI is forecast to rise 0.6%qtr.

Core inflation, as measured by the average of the

trimmed mean and weighted median, is forecast to rise 0.5%qtr/2.3%yr in the June quarter. This is a slight moderation from the 2.4%yr pace reported in Q1.

We estimate that the 6 month annualised rate of core

inflation will ease to 1.9%yr from 2.0%yr in Q1 and 2.7%yr in 2012Q4. Excluding the impact of the Carbon Price (and Q2 should be the last quarter of any residual impact on the level of the CPI) the six month annualised core inflation rate is a very acceptable1.6%yr. We think this should give some comfort to the central bank.

Housing remains key to both the core and non-tradable

measures of inflation. The forecast 0.4%qtr rise is based on a moderation of the Q1 outsized gain in dwelling purchase costs (0.5%qtr vs. 1.7%qtr in Q1), rents continuing to tick over at 0.8%qtr and a small fall in utilities due to a seasonal dip in Victorian electricity.

Health inflation moderates in Q2 due to falling

pharmaceutical prices as PBS subsidies start to kick in.

Fuel prices fell on average in the quarter, despite the

spike higher in May/June, and we think the holiday travel discounting this year will match recent June quarters.

Contributions to 0.5% qtr Q2 CPI print

Fruit & veg Houshold contents Housing Health Clothing Food ex fruit & veg Alcohol & tobacco Financial services Communications Transport Recreation -0.16 -0.07
Sources: ABS, Westpac Economics

CPI seasonally adjusted CPI ex housing

0.15 0.14

Weighted median Trimmed mean Average RBA core Average RBA core* ex carbon Traded good & services Non-traded goods & services

0.10 0.08 0.07 0.06 0.06 0.03 0.01

Sources: ABS, RBA, Westpac Banking Corporation. *Westpacs estimte. The ABS is not providing an estimate of impact of the carbon tax.

-0.2

-0.1 0.0 0.1 ppt contrib. to the quarter

0.2

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

The Q2 CPI normally experiences a seasonal drag of 0.12ppts. Normally you would expect Q2 to be seasonally softer than Q1. The ABS seasonal factors suggest that seasonality in Q2 is worth 0.12ppts compared to +0.29ppts in Q1 (ie. the seasonal factor is 0.29% higher in Q1 than in Q4). Key to this seasonality is falling pharmaceuticals (as the PBS subsidies start to kick in), some food items (pork & seafood, fruit & vegetables and other food items), womens footwear, electricity, urban transport fares and domestic & international holidays. It is important to note though that the ABS conducts concurrent seasonal adjustment to the CPI so they will have new seasonal factors for the June quarter. Fruit & vegetable prices to rise 5.2%qtr contributing 0.15ppts. Wholesale fruit prices rose 5.3% in Q2 following a 5.4% rise in Q1. In the Q1 CPI, fruit prices fell 7% opening a wide divergence to wholesale prices. Historically price changes at the wholesale/retail level do tend to converge. As wholesale fruit prices lifted again in Q2 we expect there was some catch up in retail prices hence our CPI fruit forecast of 7%qtr. Our Q2 forecast runs counter the normal seasonal pattern implied by the ABS seasonal factors (3.6%qtr). Vegetables are trickier to estimate as the volatility at the wholesale level is about double that at the retail level. In Q1 we were surprised that none of the 7%qtr rise in wholesale vegetable prices was passed on to consumers. And wholesale prices for vegetables rose a further 1.5% in June. We are forecasting a 3%qtr rise in CPI vegetable prices compared to a 2.9%qtr fall in the ABS seasonal factor. Housing is a foundation for modest inflationary pressure. Housing, with a large weight of 22.3%, is forecast to rise 0.4%qtr, contributing 0.10ppts to the CPI. This is a step down from the 1.2%qtr in Q1. The Q1 number was lifted by an outsized 4.7%qtr rise in the Victorian dwelling purchase index. This lifted the total dwelling index by 1.7%qtr but if you exclude Vic from the series, it was a much more modest 0.3%qtr. Before Q1, Vic new dwelling purchase prices averaged a 0.4%qtr rise over the past five years. New dwelling purchases (a weight of 8.7%) are forecast to rise 0.5%qtr and contribute 0.04ppts. Given there is a clear risk that Vic dwelling purchase costs fall in Q2 following the outsized gain in Q1, the risks are to the downside for this estimate. We dont believe that underlying demand for new dwellings is robust enough to support immediate widespread acceleration in dwelling price inflation. Rent inflation has been quite stable (a weight of 6.7%); our forecast for a 0.8%qtr rise follows on from a 0.8%qtr in 2013Q1, 2012Q4 and 2012Q3. Utilities, which have a weight of 3.6%, will have the normal seasonal fall (0.4%qtr) due to Victoria. Ex-housing, we are forecasting a more modest 0.4%qtr rise than the 0.5% rise in the headline CPI. Non-housing inflation is running a touch slower than housing inflation. Pharmaceuticals are a seasonal negative. Pharmaceuticals are set to have their usual seasonal fall (1.2%qtr, 0.01ppts). Pharmaceutical prices rise in Q1 then fall in Q2, Q3 and Q4. The Q1 rise is associated with the start of a new year for the Pharmaceutical Benefits Scheme and few families total spending on health breaches the threshold for government assistance. In the March quarter some families breach the threshold and hence the subsidies start to kick in.
2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0
0.4 0.3 0.2 0.1 0.0 -0.1 -0.2 -0.3 -0.4

Seasonal impact on headline CPI (ABS est)

%qtr
historical projected

%qtr
Sources: ABS, Westpac Economics

0.4 0.3 0.2 0.1 0.0 -0.1 -0.2 -0.3 -0.4

Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13

Wholesale fruit prices held onto Q1 gains

60 50 40 30 20 10 0 -10 -20 -30 -40 Jun-01 Jun-03 Jun-05 Jun-07
Sources: ABS, Westpac Economics

%qtr CPI fruit Market fruit prices CPI fcs

%qtr

60 50 40 30 20 10 0 -10 -20 -30 -40

Jun-09

Jun-11

Jun-13

Vegetable prices did not ease enough in Q2

50 40 30 20 10 0 -10 -20 -30 Jun-01
Sources: ABS, Westpac Economics

%qtr
CPI vege (rhs) CPI fcs Market vege prices (lhs)

%qtr

25 20 15 10 5 0 -5 -10 -15

Jun-03

Jun-05

Jun-07

Jun-09

Jun-11

Jun-13

Dwelling PPI vs CPI dwellings

%qtr %qtr 2.5 2.0 1.5 1.0 0.5 0.0
new dwelling CPI PPI dwelling construction
Sources: ABS, Westpac Economics

-0.5 -1.0 -1.5 Mar-09 Mar-11 Mar-13

-1.5 Mar-01

Mar-03

Mar-05

Mar-07

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

Transport price deflation kicks in this quarter. Weaker oil prices and a stronger AUD pushed petrol prices down near the end of Q1 and into the first half of Q2. This is important as the lateness of the Q1 fall still left Q1 average petrol prices up 1.2%qtr. But it does mean that Q2 petrol prices started the quarter much lower than they did in Q1 and, as a result, the average price in Q2 is 2% lower than Q1. There was a late May/June surge in petrol prices but it was not enough to lift the average much. It is, however, setting a much higher starting point for Q3 suggesting that quarter will report a significant jump in petrol prices. Motor vehicle prices are expected to continue to fall, but our 0.9%qtr forecast is a moderation from the 1.3% fall in Q1 and is in line with the 0.9%qtr print of 2012Q4. We would, however, highlight that the weakness in the Japanese yen suggests downside risk to motor vehicle prices over the next few quarters. Falling airfares complement a deflation pulse from audio, visual & computing equipment. The deflation of audio visual & computing equipment is there as usual and this quarter also gets the normal mid-year discounting for holiday travel & accommodation, particularly for domestic holidays. All up, recreation & culture is forecast to fall 1.2%qtr, contributing 0.16ppts. In 2012Q2, recreation & culture fell 1.2%qtr. Housing is key to the outlook for non-traded inflation... With such a large weight in the CPI (22.3%) it should not be surprising that housing costs (dwellings, rents, utilities, rates & other charges) represent 53% of non-tradable goods and services. Ex-housing, non-tradable inflation was 3.7%yr in Q1 vs. the ABSs estimate of 4.2%yr for non-tradable inflation. Westpac is forecasting ex-housing non-tradable inflation to lift a bit to 3.8%yr in Q2 but this is still well below our forecast of 4.2%yr for non-tradable inflation. ...with housing energy costs significantly boosting nontradable inflation. Excluding electricity and gas prices from non-tradables, the annual pace in Q1 would have printed 3.5%yr. We do expect the nonhousehold energy non-tradable price series to lift 3.7%yr in Q2. Annual pace of core inflation is at the bottom of the RBAs target band; it is under it in 6 month annualised terms. Our forecast for a 0.5%qtr rise in the average of the RBAs measures of core inflation will see the annual pace moderate a bit to 2.3%yr from 2.4%yr, a drift down from the midpoint of the RBAs inflation target. This will also result in a moderation in the six month annualised pace of core inflation to 1.9%yr from the 2.0%yr reported in Q1 and the 2.7%yr print in Q4. There is still a very modest 0.31ppts contribution to the six month annualised pace of core annual inflation due to the introduction of the Carbon Price Mechanism; without it, core inflation would be running closer to 1.6%yr (six month annualised). And the boost to core inflation due to the carbon price is already fading. It first appeared in the Sept quarter of 2012 and we expect it to have fully run its course by Q2. Inflation does not pose a threat to Australian policy makers. Justin Smirk, Senior Economist, ph (612) 8254 9336
6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0

Melbourne housing PPI vs. CPI

%qtr
new dwelling CPI PPI dwelling construction

%qtr

6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0

-2.0 Mar-01

Sources: ABS, Westpac Economics

-2.0 Mar-07 Mar-09 Mar-11 Mar-13

Mar-03

Mar-05

A lower qtr average despite late spike higher

170 160 150 140 130 120 110
Sources: ABS, Melbourne Institute, Westpac Economics

AU/l
CPI motor vehicle fuel API unleaded petrol WBC forecast

AU/l

170 160 150 140 130 120 110 100

100 Jul-09

Jul-10

Jul-11

Jul-12

Jul-13

Tradable vs. non-tradable inflation

8 6 4 2 0 -2 -4 Jun-01 non-tradables (lhs) tradables fcs (lhs) Jun-03 Jun-05 tradables (lhs) non-tradables fcs (lhs) -4 Jun-07 Jun-09 Jun-11 Jun-13 %yr
Sources: ABS, Westpac Economics

%yr

8 6 4 2 0 -2

Housing keeps the pressure on non-tradables

8 %yr
Sources: ABS, Westpac Economics

%yr
total housing costs (rhs)

non-tradeable inflation

0 Jun-01

0 Jun-03 Jun-05 Jun-07 Jun-09 Jun-11 Jun-13

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

Non-tradable inflation, housing worth 0.5%yr

7 %yr total ex housing ex housing fcs total fcs %yr 7 7

Non-tradable inflation, elect & fuel boostinng

%yr total ex elect & fuel ex elect & fuel fcs 5 5 total fcs 5 %yr 7

Sources: ABS, Westpac

Sources: ABS, Westpac

1 Mar-03

1 Mar-05 Mar-07 Mar-09 Mar-11 Mar-13

1 Mar-03

1 Mar-05 Mar-07 Mar-09 Mar-11 Mar-13

Six month annualised pace of core inflation

4 %yr
RBA target band Westpac's estimate of the Carbon Price

Headline & core ease back in Q2

%yr 4 9 8 3 7 6 5 2 4 3 1.2 0.7 0.2
Sources: ABS, Westpac Economics

%yr
avg RBA core CPI* %qtr (rhs) headline CPI %yr (lhs) avg RBA core CPI* %yr (lhs)

%qtr
* average of s.a. trimmed mean & weighted median CPI.
Forecasts

Sources: ABS, Westpac Economics

2.7 2.2 1.7

3
Forecasts

2 1 0 -1 Mar-97

0 Mar-11

0 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13

-0.4 Mar-01 Mar-05 Mar-09 Mar-13

Discretionary goods
2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 Jun-04
Sources: ABS, Westpac Economics

Discretionary goods s.a (WBC factors)

%yr 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 Jun-04
Sources: ABS, compiled and s.a. by Westpac Economics

%qtr
qtr (rhs) %yr (lhs)

%qtr
qtr (rhs) %yr (lhs)

%yr
Westpac forecast

2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5

Dec-05

Jun-07

Dec-08

Jun-10

Dec-11

Jun-13

Dec-05

Jun-07

Dec-08

Jun-10

Dec-11

Jun-13

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

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