Photographer: Brent Lewin/Bloomberg

Aussie's Steep Drop Puts Inflation Worries on Hold

  • Weaker currency boosts prices for imported goods and services
  • Breakeven rates snap longest falling streak since at least '09

The Australian dollar’s steepest three-year decline since the currency was floated in 1983 is helping temper pressures for weaker inflation.

The annual pace of consumer price gains accelerated in the final quarter of 2015 as the cost of goods and services influenced by imports climbed for the first time in a year. The bond market’s inflation expectations on Wednesday snapped the longest run of daily declines since at least 2009.

The Aussie dollar’s 32 percent decline since the start of 2013 is helping to spare central bank Governor Glenn Stevens the deflation worries that haunt his peers in Wellington, Tokyo and Frankfurt. With unemployment falling in the latter part of 2015 and the local dollar “much lower,” the second half may have marked a bottom for the trend in core inflation, according to Deutsche Bank AG.

“It is a good time” to buy inflation-linked debt, said Ben Alexander, who helps oversee $3.9 billion as a principal at Ardea Investment Management in Sydney. “Inflation has held up quite up well.”

Traders of inflation-indexed bonds were pricing in a 1.94 percent annual increase in living costs for the next 10 years on Thursday, up from 1.89 percent on Jan. 25, the lowest reading since at least 2009. Expectations for the coming three years were at 1.49 percent after climbing on Wednesday by the most since July, when the data began.

Imported Inflation

Wednesday’s consumer prices report for the fourth quarter showed the annual inflation rate for tradable goods and services rose to 0.8 percent. That ended a succession of three negative prints, while the rate for non-tradables moderated to 2.3 percent from 2.6 percent.

The boost for import-affected goods helped the consumer price index rise 1.7 percent year-on-year, compared with a 1.5 percent increase three months earlier. The two core measures watched by the RBA averaged a gain of 2 percent, slowing from 2.1 percent.

An increase in tobacco prices was one of the biggest contributors to price gains last quarter, as were rising costs associated with both domestic and international holiday travel. There are also indications that retailers are beginning to pass on price pressures, ending a squeeze on margins, according to Commonwealth Bank of Australia.

Currency Effect

“The clear signs are that retailers have put up the prices of imported goods and also service providers, particularly on accommodation and holidays, have also put their prices up,” said Michael Workman, a Sydney-based economist with Commonwealth Bank, Australia’s largest lender. “It’s a function of the lower currency as well as stronger consumer spending trends.”

The central bank will maintain its conditional easing bias, because it has helped them keep pressure on the Aussie dollar, he said.

The Australian dollar bought 70.23 U.S. cents as of 11:48 a.m. in Sydney and touched an almost seven-year low of 68.27 cents on Jan. 15. It declined 11 percent in 2015 after sliding more than 8 percent the year before and a 14 percent drop in 2013.

A permanent 10 percent decline in the currency is estimated to raise year-ended inflation by as much as half a percentage point in the two-to-three years following the depreciation, a 2014 research paper from the Reserve Bank of Australia’s economic analysis department showed.

The RBA targets core inflation of 2 percent to 3 percent on average, meaning it tolerates temporary moves above and below that target. It forecasts the measure will be within that range through till the end of 2017. 

Currency moves fit into the category of things that create one-time effects, while it’s ongoing price pressures such as annual increases in cigarette taxes that matter for inflation-linked bonds, said Ardea’s Alexander.

“We’re in this world where low inflation is a problem, not high inflation,” he said. “Talking about it that way around, inflation’s been good in Australia relative to the rest of the world.”

Before it's here, it's on the Bloomberg Terminal.