Q1 CPI – not low enough for a May cut

With Q1’13 CPI much lower than anticapited the obvious question is if the RBA will respond by cutting rates in May.

It it hard to say for sure, but i think the chance of a cut in May is no better than 25%. For, while weak inflation does suggest that demand is running a little behind supply, some of the details suggests that the current weak inflation pulse is possibly about some odd things that are going on.

In particular, large drop in clothing — -3.9%q/q — seems to have been due to warm weather late in Q1, which led to heavy discounting of autumn stock by retailers. This and the -0.8%q/q drop in food prices seem unlikely to reflect movements on the demand side of the economy.

This is the reason we saw a large drop in tradable CPI (-1.2%q/q). On the other hand, it’s hard to dismiss the 1.3%q/q increase in non-tradable CPI (as i have done in the past, as it’s mostly been tax-like regulated price increases). These numbers are not seasonally adjusted, however a rough analysis suggests that non-tradable CPI was ~1%q/q.

With non-tradable CPI ~1%q/q and house prices rising at ~5%y/y AR in Q1, it’s hard to make a case that domestic demand is weak and requires support.

Sure, the fact that CPI is lower than the RBA expected (they need ~0.75%q/q in Q2 to hit their 2.5%y/y projection for core CPI in June 13), means that the hurdle for a rate cut is lower — but i don’t think the case for a rate cut in May has been made.

If the demand blip in March (the NAB business survey and Jobs data were weak) is confirmed, the RBA will likely ease later — perhaps June, perhaps later — but i do not think the case has been made for May.

The market is currently pricing is ~10bps of cuts (a 40% chance) — up from ~7bps the prior day (a 28% chance).

I think that’s too much — but then i thought so yesterday before CPI…