With the combination of very weak import and producer prices, most economists are now flagging the risk of a significant downside surprise to the already low consensus forecast of about 0.5% to 0.6% in Q1 (and hence a cut in May and possibly June). In fact, I have not seen anybody talking of upside risks at this juncture. Here are Citi's comments, which capture the dovish expectations neatly:
The downward surprise on the PPI result suggests that there is downside risk to the consensus CPI forecast of 0.6%. Over the past two years, surprises in the quarterly PPI have tracked reasonably well with subsequent surprises in the quarterly CPI. Today’s PPI surprise is the largest downside surprise since June 2009...
Important PPI components also argue for a soft Q1 CPI result. Food prices (down 1.1%) and house construction (flat) were weaker than in Q4. These items do map over reasonably well to CPI, which suggests that there is unlikely to be an upward risk to the CPI from these items. Utilities like electricity, gas and water were higher (up 2.1%), but the increase was close enough to our forecast for this item not to bias up our CPI forecast of 0.6%. Tobacco product manufacturing increased strongly (up 7.8%), but the seasonal adjustment mechanism should moderate such any similarly strong reading in the headline CPI, while such a large increase is likely to be trimmed out of the underlying CPI measure...
The PPI result sets up the medium-term inflation picture as one that is favourable for the RBA. Should tomorrow's underlying CPI result be benign (we say it will), then the question becomes can the RBA even consider something like a 50 bp cut in May or back-to-back cuts to get ahead of the inflation curve?
