Australian Dollar: Why the Knee-jerk Inflation Data Sell-off Was Quickly Faded

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The Australian Dollar was sold following softer-than-expected monthly inflation figures, but weakness was shortlived as analysts looked under the hood and saw some concerning trends.

Australia's CPI inflation indicator remained anchored at 3.4% year-on-year for the third month in a row in February, which some economists say indicates that price pressures are moderating.

The Australian Dollar fell after the data release as the market was looking for a stronger 3.5% outcome. However, the details in the report indicated that weakness soon faded.

The Pound to Australian Dollar exchange rate rose to 1.9368 following the release before paring the advance to 1.9337. The Australian Dollar to U.S. Dollar exchange rate fell to 0.6511 before paring the fall and recovering to 0.6531.

"AUD/USD fell by around 30pips following the release of the weaker than expected Australian CPI indicator for February," says Kristina Clifton, an analyst at Commonwealth Bank of Australia. "However, most of the fall was subsequently unwound."

Stephen Wu, an economist at Commonwealth Bank, says inflation looks to be moderating faster than the RBA expects, noting downside risks to existing forecasts. "The softer inflation outcome today marries up with the slowing momentum in the economy and weak domestic demand growth."

Economists at ANZ say although the headlines are to be welcomed, there are signs of ongoing inflation persistence in some sectors of the basket.

"The RBA would take comfort in the current trajectory of inflation, with inflation on track to undershoot their Q1 forecast of around 0.8% q/q. But there are some signs that we may encounter the 'last mile' challenge," says Madeline Dunk, an economist at ANZ.

Image courtesy of ANZ.

'Sticky' inflation dynamics are still seen in the services and non-tradables components at 4.2% y/y and 4.8% y/y, respectively. This was up from 3.7% y/y and 4.7% y/y in January.

Goods (2.9% y/y) and tradeables (0.8% y/y) have been driving most of the recent disinflation.

The RBA said at its March update that it sees risks to inflation as being evenly balanced and wants to see services sector inflation fall before considering a rate cut. The market consensus is that the first cut will be delivered in September.

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The monthly inflation indicator is a precursor to the main quarterly inflation release, which is what the RBA bases its policy decisions around.

Justin Smirk, Senior Economist at Westpac, says the mid-month of each quarter provides us with an important update on household services, and so February sets the tone for much of this group for the quarter.

"This presents an upside risk to our current quarterly CPI forecast," he says.

Signs of ongoing inflationary persistence in the non-tradeables and services could keep the RBA on edge and ensure it is the last of the major central banks to cut interest rates.

This would provide the Aussie with some tailwinds over the coming months.

If inflation falls at a faster pace than expected in the coming months, the start date for rate cuts could come forward, which would weigh on the Aussie Dollar.