CPI reweights to drag on inflation

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From UBS:

ABS will introduce the 17th series of the CPI in 2H17

The ABS typically reweights the CPI every 5-6 years, with the 17th series due to be introduced in 2H17.

The upcoming reweight will adjust the expenditure shares of CPI to the latest household expenditure survey. This ‘corrects’ the positive substitution bias (i.e. CPI overstating ‘true’ inflation) occurring because spending tends to rise (fall) on items where relative prices have declined (risen), but the CPI’s weights are fixed.

Our analysis implies CPI will overstate ‘true’ inflation by ~¼%pt y/y in Q417

To quantify how much the out-dated weights have seen CPI overstate ‘true’ inflation, we examine three scenarios for the upcoming reweight; 1) returning the base weights to 2011 levels, 2) adjusting the expenditure shares based on more timely GDP data & 3) a UBS forecast for the weights based in part on industry/sectoral trends. We find that on average, by Q417 y/y headline CPI as measured will overstate inflation by ~¼%pt.

The ‘base effect’ of the reweight could also see CPI drift ¼%pt lower over 2018

If trends over the coming year are unchanged, the reweighting down of higher inflation items, and up of low inflation items, could see CPI drift ¼%pt lower over 2018. Indeed headline and underlying CPI fell at least 0.4%pts after 3 out of the past 4 reweights & the RBA cut (Figure 1). Despite this impact, fading headwinds from commodity prices and the rise in global inflation support our view of a gradual rise in inflation ahead.

Technical change caps upside surprises to CPI; RBA to hold until at least mid-18

Overall, we remain comfortable with our below consensus CPI outlook & still see core CPI returning to the band in 1H18. Importantly, the reweight is largely technical, but with inflation expectations tied to published CPI & a growing share of wages linked to CPI, the reweight reinforces our long-held view of wage-price disinflation. The reweight may also work to offset any stronger than expected upside inflation pressure in 2018.

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About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.