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RBA Inflation Warning Doubted on Wages Puzzle: Australia Credit

Bond traders aren’t buying the Reserve Bank of Australia’s warnings that inflation may accelerate to the top of policy makers’ target range.

The yield gap between nominal debt due 2015 and comparable inflation-linked bonds, a measure of price expectations, was 2.17 percentage points yesterday. While the figure rose this year, it’s short of the 2.25 percent to 3.25 percent the RBA projects for the 12 months to December. Policy makers upgraded their forecasts after data last month showed prices rose at the fastest pace in two years.

The divergence between traders and the RBA suggests some investors are reluctant to give up the safety of government debt and bet on growth as domestic mining investment slows amid a drumbeat of deflationary warnings for the global economy. The central bank said Feb. 18 the jump in prices was “a puzzle,” with a weaker currency and reviving housing investment fueling inflation even amid the slowest wage growth on record.

“It’s a short-term pickup in inflation, not a trend,” said Hideo Shimomura, the chief fund investor in Tokyo at Mitsubishi UFJ Asset Management Co., which oversees the equivalent of $68.4 billion. “While the U.S. may recover, in Australia you have an end to the mining boom.”

Inflation as measured by consumer prices will probably climb to 3.25 percent in the year ended June 30, the RBA predicts, which would be the most since the third quarter of 2011. The central bank targets inflation of 2 percent to 3 percent on average.

Bond Retreat

Policy makers raised their forecasts this month after a Jan. 22 report showing a consumer price index climbed 2.7 percent in the fourth quarter from a year earlier, the fastest rate since 2011.

Inflation picked up after Reserve Bank Governor Glenn Stevens spent last year trying to support the economy by cutting the benchmark interest rate to a record low of 2.5 percent, which pushed the Australian dollar down 14 percent in its biggest slide since 2008. The aim was to stimulate consumption, construction and exports as mining slowed.

Australia’s 10-year bonds yielded 4.14 percent yesterday in Sydney, almost matching the average over the past six months. Shimomura said he would like to buy at 4.25 percent. The yield is 1.44 percentage points more than what investors get from 10-year Treasuries.

Bonds have since retreated 0.7 percent this month, based on the Bloomberg Australia Sovereign Bond Index. (BAUS) They started the year with a 1.4 percent gain in January, the biggest rally in nine months, the data show.

Buy Protection

The local dollar traded at 90.18 U.S. cents as of 5 p.m. yesterday, up 3 percent for the month.

Roger Bridges, the head of fixed income in Sydney at Tyndall Investment Management Ltd., a unit of Nikko Asset Management Co., said it’s a good idea to protect against rising costs.

Tyndall, which oversees the equivalent of $20.8 billion, bought inflation-linked debt in the fourth quarter of last year, he said. The bonds’ face value moves in tandem with the consumer price index, and interest is paid on the adjusted value.

“The weak currency is suggesting the headline CPI rate should be high, at the upper end or over the Reserve Bank’s target,” Bridges said.

The threat of falling prices, not inflation, is occupying policy makers worldwide. International Monetary Fund Managing Director Christine Lagarde in January called deflation an “ogre.” Bank of Japan Governor Haruhiko Kuroda this week expanded his effort to spur prices in the nation. In the U.S., the Federal Reserve’s preferred measure of prices has been below its 2 percent target for 20 months.

The RBA has struggled to explain the jump in costs.

CPI Puzzle

“It was likely the inflation reading contained some noise as well as some signal about inflationary pressures, but also presented something of a puzzle in interpreting the mix of activity and price data,” it said in minutes of its last meeting released Feb. 18. A falling currency would add to inflation, though the outlook for slightly slower wage growth would keep domestic costs contained, it said.

Housing prices in Sydney have risen for eight straight months to a record, based on the RP Data-Rismark Daily Home Value Index. Offsetting that, wage costs rose at an annual rate of 2.6 percent in the fourth quarter, a government report showed yesterday, the smallest gain in data compiled by Bloomberg that go back to 1998. The economy lost jobs in December and January.

Below Potential

In China, the largest buyer of Australia’s commodities, a private report tomorrow will show the preliminary estimate of a manufacturing purchasing managers index was unchanged at 49.5 in February, according to the median estimate in a Bloomberg News survey. The reading below 50 would signal a second month of contraction.

Australia’s gross domestic product will expand 2.8 percent in 2014, versus 2.9 percent in the U.S., based on Bloomberg surveys of economists, marking the first time the nation will lag behind the world’s biggest economy since 2010.

The difference between actual and potential GDP for Australia, the so-called output gap, is negative 1.2 percentage points, according to data compiled by Bloomberg.

“There’s a case to question whether growth might be below potential for some time, as the labor market and income growth remain weak,” said Justin Tyler, a Sydney-based senior investment manager at Aberdeen Asset Management Plc, which oversees the equivalent of $11.7 billion in Australia. “That’s not the ideal backdrop for higher inflation expectations.”

To contact the reporter on this story: Wes Goodman in Singapore at

To contact the editor responsible for this story: Garfield Reynolds at

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