AUD: Record Low Core Inflation Increases Pressure on RBA to Ease – MUFG

AUD: Record Low Core Inflation Increases Pressure on RBA to Ease – MUFG

Lee Hardman, Currency Analyst at MUFG, notes that the Australian dollar has declined sharply in the Asian trading session falling by over 1.5% against the US dollar following the release overnight of the weaker than expected Australian CPI report for Q1.

Key Quotes

“The report revealed that measures of core inflation were the lowest ever recorded. The average annual rate of core inflation declined to 1.5% while the headline rate was even weaker at 1.3%. The RBA will have to drop their description that core inflation is close to target which will require the RBA to downgrade their inflation forecasts in the upcoming May Statement.

Widespread weakness in import prices suggests very little pass through from the exchange rate which the RBA is relying on to help lift core inflation back towards the middle of their target band between 2.0% and 3.0%.

The disappointing CPI report opens the door for the RBA to lower rates further as soon as at their next policy meeting on the 3rd May. The RBA clearly stated in their last policy statement that “continuing low inflation would provide scope to ease policy further should that be appropriate to lend support to demand”. A downgrade to their inflation forecast would justify a rate cut and help preserve the credibility of the RBA’s inflation target.

However, it is still not a certainty although likely that the RBA will lower rates at next week’s meeting as recent economic activity has continued to improve as evident by the unemployment rate falling to a new cyclical low of 5.7% providing some cautious over delivering an imminent rate cut to support growth.

By lowering rates it will help to dampen the recent strengthening of the Australian dollar which the RBA is likely to become even more sensitive over now. Lowering rates will at the margin undermine carry demand for the Australian dollar which has been building since the Fed adopted a more cautious stance towards further monetary tightening. The Australian dollar has benefitted as well from building optimism that policy stimulus is offering more support from economic growth in China in the near-term.

The sharp rebound in iron ore prices early this year provides fundamental support for the stronger Australian dollar even if we doubt that those gains can be sustained beyond the near-term. In these circumstances, we doubt that the Australian dollar will weaken much even if the RBA lowers rates further in the near-term. Continued firmness in the Aussie will contribute to the RBA’s concerns.”