Australia Producer Prices Jump by Record in Q1

Australia's producer prices surged by a record 1.9 percent last quarter, far above forecasts and sparking concerns the country's inflation problems will not be tamed as quickly as many had hoped.

The Australian dollar climbed and bonds slid as prices at the final stage of production (PPI) increased by 4.8 percent in the first quarter, compared to the same quarter last year. That was a seven-year high and made some wonder if the consumer price report, due on ednesday, might also show an alarming increase.

"It suggests some upside risk to the inflation numbers," said Stephen Halmarick, co-head of market economics at Citi.

That was a worry for the Reserve Bank of Australia (RBA) as analysts had already expected core inflation to accelerate to its fastest pace in almost 17 years in the first quarter.

Core inflation, which is what policymakers focus on, is seen rising an annual 3.9 percent, up from 3.6 percent in the previous quarter and well above the RBA's 2 to 3 percent target zone.

With the cost of production rising so sharply, it might also mean that RBA Governor Glenn Stevens was premature when he recently said consumer inflation was likely to slow faster than first believed.

"It doesn't mean the RBA is any more likely to hike again," said Brian Redican, a senior economist at macquarie. "But it does suggest that inflation could be a problem for longer, and so put off the timing of any rate cut down the track."

Investors seemed to suspect as much with markets now showing only 27 basis points of cuts priced in for the next 12 months, compared to more than 40 basis points last week.

Home Grown

Analysts were particularly concerned that so much of the pressure at the producer level was home-grown. Domestic producer prices leaped 2.0 percent in the first quarter, the largest rise since the series began in 1998.

Driving the inflation was a 10.7 percent increase in the cost of petrol, while the price of electricity, gas and water supply rose 3.1 percent and the cost of building construction climbed 1.9 percent.

"Even the depressed housing sector showed a big rise, which suggests this is cost-push pressure rather than demand-pull," added Redican. "That's troubling for the RBA as it's harder to fight cost-driven inflation with higher interest rates."

The central bank has hiked four times since August, taking the cash rate to a 12-year peak of 7.25 percent, as it grappled with widening price pressures in a booming economy.

Recently, however, the economy has shown clear signs of cooling with retail sales falling and consumer confidence slumping, while demand for credit waned and businesses reported a marked slowdown in activity.

As a result, the RBA indicated that tighter financial conditions and moderating demand would likely bring inflation back down to more comfortable levels in the medium term.

Such a surge in producer costs as demand was slowing suggested retail and company profit margins were being squeezed, with potentially grim implications for hiring and wages.

"It looks like retailers took an horrific hit on margins," said Stephen Roberts, a research director at Lehman.

"Indeed, the first quarter looks horrible for the economy as a whole. Consumption could well have been negative and there's a big drag from trade," he added. "It may be that GDP (gross domestic product) actually shrank last quarter."