World Inflation II: Commodity Currencies - AUD, NZD, CAD

The current wave of inflation has been brought about by commodities. We, therefore, feel it necessary to talk a look at countries with the so-called 'commodity currencies'. We found Australia is the one facing more severe price pressures. For New Zealand, inflation has been affected by one-factors while underlying pressures remained subdued. Both headline and core inflation in Canada accelerated but the central bank is not likely to change its dovish view in coming months.

Australia: Headline inflation rose +1.6% q/q in 1Q11, accelerating from +0.4% in the prior quarter, as food and energy prices surged. Price levels also jumped +3.3% from a year ago. In coming quarter, inflation pressures will elevate further as reconstruction efforts after the floods will raise materials prices while tightening job market will increase wage pressures. At the quarterly monetary policy statement, the RBA revised up its underlying inflation forecasts to 3% in December 2011 from February's projection of +2.75%. By December 2013, inflation will rise to +3.25%, exceeding the central bank's upper limit.

The RBA also signaled explicitly that 'further tightening of monetary policy is likely to be required at some point for inflation to remain consistent with the 2-3% medium-term target...The Board will set policy to ensure a continuation of the low and stable inflation that has made an important contribution to Australia's strong economic performance over the past two decades'. RBA's forecasts were made based on the assumption that the cash will increase +25 bps by early 2012 and another +25 bps by mid-2013 with AUD/USD at 1.07. The currency pair fell to 1.069 at close yesterday. If Australian dollar continues to correct from its peak, inflation pressures should rise further.

The RBA also revised it growth forecasts with the pace slowing in the near-term before gathering momentum again later in the year. GDP is expected to grow +2.5% in 2Q11 (February's projection: +3.25%), followed by expansions of +4.25% (February's projection: +4.25%) and +3.75% (February's projection: +4.00%) in 4Q11 and 4Q12 respectively. As noted in RBA's meeting statements, the central bank repeated its concern over households. As stated in the quarterly report, households remain 'cautious in their spending and borrowing decisions'. Despite optimism about the economic outlook, households 'are not as optimistic about their own finances. Higher prices for utilities, fuel and food, as well as higher mortgage rates, appear to be weighing on consumer confidence'.

What the market concerns the most is the tightening cycle. The RBA left the cash rate at 4.75% for a 5th meeting in May. We see from the policy statement that policymakers are less relaxed with the inflation outlook at the May meeting when compared with the April one. Yet, policymakers preferred to 'wait and see' for the time being before resume tightening. The bottom-line is that further rise in inflation should eventually trigger the RBA to increase interest rates again in the second half of the year.

New Zealand: Inflation rose +0.8% q/q in 1Q11, slowing from prior quarter's +2.3% jump which was mainly driven by the +2.5% increase in GST in October. This one-off effect also affected the year-over-year reading which soared +4.5% y/y in 1Q11 from +4% in 4Q10. Indeed, the set of inflation reading missed market expectations. More importantly, inflation remained subdued excluding petrol and administrative charges, thanks to strong New Zealand dollar. In the first quarter, non-tradables inflation component increased +1.1% q/q, while tradables inflation climbed only +0.5% q/q.

The market priced in a lower possibility of a rate hike this year after release of the inflation report on April 18. Indeed, the RBNZ is facing less pressure in tightening monetary policy given the downside surprise in inflation. At the meeting on April 28, policymakers stated that the current level of the OCR is likely to 'remain appropriate for some time' given the outlook for core inflation and economic disruption due to the earthquakes. In our opinion, the central bank will likely leave the policy rate unchanged at least for the rest of the year.

Canada: Headline inflation jumped to +3.3% y/y in March, from +2.2% in February, due to surges in food and energy prices. Core inflation remained within BOC's range, but the rise to +1.7% y/y, almost doubling the +0.9% gain recorded in the prior month, signaled inflation pressures have begun to affect the underlying trend. The BOC will eventually resume the tightening cycle in order to curb inflation. Yet, policymakers are not 'eager' to do so.

At an interview with CNBC, BOC governor Mark Carney said that appreciation in Canadian dollar has posed "a downside risk to growth and inflation in Canada'. Concerning growth, which has been 'slowed quite markedly in the second quarter', the underlying track is around +2 to +2.5% through the balance of the year. However, uncertainties remained. The government appeared to stay comfortable with the inflation outlook and believed inflation expectations are anchored to core inflation in Canada.