Australia First-Quarter Producer Prices Are Surprisingly Soft

Australia's producer prices were unchanged in the first quarter, confounding forecasts for a rise and offering hope that inflationary pressures were slackening enough to avoid another increase in interest rates.

The steady result for the price of finished products (PPI) was the lowest in two years and contrasted with market estimates of a 0.6% rise in the first quarter. Growth for the year eased to 2.8%, the slowest pace since mid-2004, from 3.5% in the fourth quarter.

"This is obviously a very low reading and good in terms of inflation pressures," said Steven Milch, head of economic research at St. George Bank. "A strong Australian dollar has no doubt helped, but even the domestic elements were well behaved," he added.

The price of imported goods fell 1.1% overall in the first quarter, while domestic goods rose a mere 0.1%.

The Australian dollar climbed as high as 79 U.S. cents in the first quarter, from around 76 cents in the fourth quarter, and has since surged to 17-year highs near 84 cents.

The currency dipped slightly to 83.55 cents on Monday as the low producer price reading was taken as lessening the risks of another rate rise from the Reserve Bank of Australia (RBA).

Likewise bond and interest rate futures firmed as the market trimmed the chances of a tightening in May to around 46% from 54% at the end of last week.

Speculation about a rate rise has been rampant following a run of robust economic figures, including strong retail sales and credit growth and a drop in unemployment to 31-year lows.

Whether the central bank does move in May might depend on what the consumer price figures (CPI) for the first quarter show when released on Tuesday.

Weighing CPI

Analysts said the producer price series did not have a close correlation to CPI, their weighting structure being radically different. But some parts of the PPI provided a useful guide on some consumer prices.

One of these was construction costs, which rose a sizable 0.9% in the first quarter, though the cost of building houses rose a more moderate 0.5%. On the other hand, the price of some agricultural goods, notably bananas, fell by more than some analysts expected.

"I guess if we look at the domestic front, they were pretty well behaved and the benign PPI reading for both the December and March quarters suggests downside risks to the CPI number," said Su-Lin Ong, a senior economist at RBC Capital Markets.

Analysts are generally looking for a moderate 0.6% rise in the CPI in the first quarter, thanks in part to the slump in banana prices after a surge last year following a cyclone that devastated the crop.

That would see annual inflation slow to 3.0%, from 3.3% the previous quarter. For setting interest rates, the central bank focuses on its measures of underlying inflation which are expected to show gains of around 0.6% in the first quarter.

Such an outcome would lower annual underlying inflation to 2.8%, from 3.0% in the fourth quarter, taking it back within the RBA's 2% to 3% target band.

"The PPI makes us comfortable with our CPI forecast tomorrow which appears to be a little on the low side of expectations," said John Peters, a senior economist at Commonwealth Bank. "We don't think the price numbers for the first quarter will be the smoking gun for the Reserve Bank to lift rates in terms of inflation," he argued.