Australian CPI Surpasses Expectation; Market Eyeing Further Rate Cuts

Let us have a look at the recently announced inflation figures by the Australian Bureau of Statistics:

ABS June 2019 Quarter Inflation Data

The Australian Bureau of Statistics (ABS) has released the headline consumer price index (CPI) for the June Quarter 2019. Surprisingly, the annual CPI inflation surpassed the expectations of market experts by rising 1.6 per cent against the anticipation of 1.5 per cent.

For the June 2019 quarter, the CPI improved 0.6 per cent against the forecast of 0.5 per cent. However, there was no movement in the headline CPI during the March 2019 quarter.

As per ABS, the most substantial increase was seen in the automotive fuel where the prices rose 10.2 per cent during the June quarter. The automotive fuel prices recovered after declining by 8.7 per cent in the previous quarter. The fuel costs increased in all the Australian capital cities in the quarter, with a maximum rise of 11.8 per cent seen in Sydney.

The prices of international holiday, travel and accommodation; and medical and hospital services also rose by 2.7 per cent and 2.6 per cent, respectively. The rise in medical and hospital services was due to an annual surge in Private Health Insurance premiums. Adelaide saw an increase of 3.8 per cent in prices of medical and hospital services during the period.

On the other hand, fruit prices fell significantly by 4.1 per cent during the quarter, followed by electricity (1.7 per cent down) and domestic holiday, travel and accommodation (1.5 per cent down).

The prices of food and alcoholic beverages also declined by 0.4 per cent, driven by an improvement in supply of fruit and vegetables. Perth exhibited a lesser fall in comparison to other capital cities as the fruit and vegetable supply in the area was affected by localised drought conditions.

Experts View on Inflation Figures

According to the market experts, although the June quarter inflation has surpassed the expectations to some extent, but this increase is not enough to convince the central bank to avoid rate cut in the near future. The inflation is still far from the RBA?s inflation target band of 2 to 3 per cent.

The experts are still firm on their anticipations of further rate cut before the end of 2019. The RBA has already reduced the interest rates twice this year in succession, taking it to a level of 1 per cent.

Few economists have anticipated a reduction of 25 basis points in interest rates in November 2019 as the inflation has remained out of the target band for a 14^th consecutive quarter in Australia. Further rate cuts by the central bank and the supportive regulatory measures might lead to a further improvement in inflation by the end of the year. As per economists of National Australia Bank Limited, the central bank is likely to hold the interest rates at 1 per cent in August while it might cut rates again in November after receiving further information on the economic growth, labour market and the effect of both the June-July rate cuts and government's tax refunds.

Effect of Lower Interest Rates on Stock Market

The equity market usually tend edge up when any rate cut is announced in the economy, with the growing expectations of increased spending and investments by businesses and consumers. However, sometimes the market responds on the basis of the driving force behind the rate cut. For example, if the rate cut is done in response to the economic slowdown, the stock market might feel the pinch. The impact of an economic movement differs on different sectors. For instance, it can be observed that consumer staples stocks tend to perform better than consumer discretionary stocks at the time of weak economic conditions because consumer staples are always in demand, no matter how the economy performs.

There are few stocks that are largely influenced by the changes in interest rates, which are known as interest sensitive stocks. Primarily, the financial institutions and the companies paying high dividends come under this category. The banks and the financial institutions are the most sensitive to interest rates among all the other market players. The earnings of these financial institutions depend on the levels/changes in interest rate. A rise in interest rate raises banks? profitability, increasing the yield on their reserve cash holdings. On the other hand, the banks tend to lose deposits when the interest rate is low as the investors find more attractive options for investment other than saving deposits. This means that bank stocks are likely to be adversely affected by fall in interest rates.

The S&P/ASX 200 Financials (Sector) Index has generated a return of ~19 per cent in 2019 to-date. The table below summarises the current stock price and the YTD return of big four banks (NAB, WBC, ANZ and CBA):

A reduction in interest rates also increases the demand for bonds, raising bond prices. The rise in bond prices lowers the bond yields which further lowers the borrowing costs for the government and corporations. The lower yield bonds are the higher-grade bonds that are exposed to less default risk. This means that the expected rate cut by RBA is likely to reduce the bond yields, making coupon payments more attractive.

Commodity Stocks: If the central bank reduces the interest rates as expected, investors are likely to invest more in the commodities like gold, iron, oil etc. At times of a lower interest rate, investors tend to flock towards safe haven assets that offer relatively high return.

The S&P/ASX 200 Resources Index that consists of the companies belonging to the commodities sector has generated a return of ~24 per cent in 2019 to-date. The table below summarises the current stock price and the YTD return of few commodity stocks (FMG, RSG, AWC, BPT and CSR) under S&P/ASX 200 Resources Index amidst interest rate cuts by RBA this year-

Consumer Staples Stocks: It has been observed that prices of consumer staple stocks usually rise during interest rate cuts. During the time of uncertain economic events, these stocks are considered as a safe investment option.

The S&P/ASX 200 Consumer Staples Index has delivered a return of over 20 per cent in 2019 to-date. The table below summarises the current stock price and the YTD return of few consumer staples stocks (MTS, A2M, WOW, WES and CCL) under S&P/ASX 200 Consumer Staples Index amidst interest rate cuts by RBA this year :

Health Stocks: The health stocks are generally seen as stable assets in low interest rate environments. These healthcare companies usually pay decent dividends even at the time of uneasy economic periods. A slowdown in economy cause little impact on the health sector as individuals will continue the use of healthcare services despite economic slowdown.

The S&P/ASX 200 Health Care Index has delivered a return of ~24 per cent on a YTD basis. The table below summarises the current stock price and the YTD return of few health care stocks (SIG, RMD, RHC, COH and API) under S&P/ASX 200 Health Care Index:

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