The Trade Week Ahead - Inflation Like Its 2015 Again?

The AUD over the last week or so has been flighting solid domestic data (upside) with geo-political and US economic strength (downside).

Case-in-point was the AUD’s reactions to the very solid employment numbers last Thursday. The initial reaction was a spike higher on the 50,900 jobs added and the unrounded unemployment rate falling to 5.37%. The spike into the 74 handle was fast and well bid however eased back into 73 on further digestion of the employment numbers.

Now the caveat here is geo-politics has swung around against the USD after the President singled out the EU and China for ‘manipulating’ their respective currencies on Friday night, this sent the USD plummeting and is now a new trade risk to currencies across the board.

However this week I expect the AUD to trade similar to that of the employment release – spike on the release before easing as the granular detail is likely to shows gaps and slack still remain, here is why.

The RBA’s 1959 charter encapsulates a full gamut of mandates, from GDP growth to employment to monetary supply however the core mandate of the RBA is to maintain core inflation between 2% and 3% and to maintain this the RBA uses its major lever in rate changes.

Looking to the Q1 release as a baseline, headline inflation was a touch softer than forecasted falling back below 2%yoy as the volatility seen in food and energy pricing slowed the rate of pricing. Underlying inflation however was firmer than forecasted and a full 15 basis points ahead of the RBA’s full year estimates as trimmed mean and the weighted mean CPI snapped out of 5 consecutive quarters of malaise to see trimmed mean inflation hit 1.9%yoy its highest read since Q3 2015. AUD fell on the headline read before snapping back on core measures.

The trimmed mean momentum was down to the likes of health and education which are expanding at a rate of around 2.5%yoy, however a major contributor has been housing. This will be key to the release on Wednesday; house price have been on the slide in the east coast and will filter into the Q2 read – the question for the AUD is how much of an impact will this have on core inflation?

Components of headline and core inflation

• Transport – this sub-sector encapsulates fuel – energy prices over the April to June period have spiked. Current estimates are for quarter-on-quarter growth in transport is 2% with year-on-year growth at 5.8%.
• Housing – Quarter-on-quarter growth is forecasted at 0.5% down from 0.7% in the first quarter.

The drivers of inflation

• Commodity markets have been volatile over the quarter with oil booming while the likes of copper have fallen back strongly on the risk for the US-China trade war.
• Australian jobs growth is now averaging 20,000 jobs a month year-to-date. However underutilisation remains stubbornly high. Employment subsectors in both the GDP and PMI releases show increases in wages, however officially it is yet to materialise.

Therefore on a headline view: higher oil prices, a fall in the AUD and food price increases present an upside risk to headline figures on Wednesday. However, underlying figures are likely to have moderated in Q2 as housing slowed from tighter credit conditions, sluggish wage growth and sanguine retail sales.

The AUD therefore is likely to spike higher on the release before moderating. I see a possible 74.6 even 74.8 target being reach on the release (if we hold at current levels) before easing in the afternoon and then falling further in European and US trading.

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