CPI - what does it mean for commercial property?  | 26 October 2016
CPI and Australian Commercial Property | October 26 2016

Australian consumer price data for Q3 2016 indicates that while inflation remains below the Reserve Bank of Australia’s (RBA) target band, there are signs of stronger price growth, indicating we may be near the inflation low for this cycle. This provides mixed signals for Australian commercial property. 

For the retail sector, the data indicate both tradeable and non-tradeable goods inflation appears to have stabilised, suggesting improved pricing may support retail sales growth. However, this is likely to be limited by soft wages growth and ongoing competition in the supermarket and apparel sectors.

Stronger inflation may also put upward pressure on bond yields, limiting demand for Australian commercial real estate and A-REITs. However, the commercial real estate bond yield spread remains very large and Australian commercial real estate continues to look attractive compared to many overseas markets, suggesting investment demand should remain solid.

Consumer price inflation growth by category, annual change %​

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What happened?
Consumer price data for Q3 2016 was released today by the Australian Bureau of Statistics (ABS). The headline inflation data show annual growth of 1.3%, up from 1.0% in June and price growth over the quarter rose to 0.7% from 0.4% in June. The growth was stronger than expected with the consensus estimates at 0.5% quarter on quarter (QoQ) and 1.1% year on year (YoY).

The headline figure includes some items with volatile pricing, so the RBA tends to keep a closer eye on measures of ‘core’ inflation such as the Trimmed Mean and Weighted Median. These rose by an average of 1.5% over the year. At 1.5%, the figure remains below the RBA’s target range of 2%-3%, the low price pressure being a factor in the RBA’s decision to cut the cash rate to 1.5% in August. The market, as indicated by ASX 30 Day Interbank Cash Rate Futures, was yesterday pricing in the chance of another rate cut at next Tuesday’s RBA meeting at just 16%. The low core inflation data may increase the odds of another rate cut, however, emerging signs of price growth in some areas may temper this.

Unlike previous quarters in 2016, price growth across the various categories was generally positive (Figure 1).  While most price growth continues to appear in non-discretionary categories such as health and education there was also growth in a number of ‘retail’ categories including appliances, furnishings and apparel. The strongest price growth was in the alcohol and tobacco category and was largely due to tobacco tax increases. Food price growth picked up on a surge in fruit and vegetable prices, up 11.6% QoQ. Falling utility prices had been dampening overall CPI increases, however in Q3 utility costs had their strongest increase since the end of carbon pricing with electricity costs rising 5.4% QoQ (Figure 2).

Tradeable and non-tradeable goods price growth appears to have stabilised after several quarters of slowing growth (Figure 3). Tradeable goods price growth was 0.7% over the year. Still low, though it had averaged zero growth over the previous six quarters. Tradeable goods inflation is usually correlated with changes in the Australian dollar (AUD), however, this relationship has broken down recently (Figure 4). The break appears correlated to the relatively soft petrol prices, which now appear to be stabilising (Figure 5). 

Weak apparel price growth also contributed to low tradeable goods inflation. While apparel price pressure is still soft, the 1.2% YoY growth recorded this quarter is the strongest since March 2012. The soft growth is likely due to increased price competition from new international retailers such as H&M, UNIQLO and Zara as well as increased use of mobile technology for price comparison.
What does it mean?

Retail
Areas of increased competition such as apparel and supermarkets have contributed to weaker retail price growth though there are signs prices are stabilising. Sectors with stronger price growth, such as household goods, are continuing to benefit from the strong east coast housing market and small business tax deductions. This suggests the downward pressure on moving annual turnover growth will begin to dissipate and sales growth improve (Figure 6).

That said, the upside is likely to be limited by factors such as weak income growth. Employment data, released last week, show a spike in part-time employment.  This is part of a continuing trend associated with the end of the mining boom and is correlated with relatively weak wages growth (Figure 7).


Investment Demand
A low inflation, soft economic growth environment has resulted in very low interest rates across the globe. This led to a global hunt for yield and relatively strong demand for Australian commercial property. The relatively wide property income – bond yield spread has supported the demand for Australian commercial property. Whilst today’s data suggest we may be near the low point for inflation in this cycle and put upward pressure on bond yields, they would need to increase significantly before Australian commercial real estate begins to look relatively expensive (Figure 8). In addition, Australian commercial real estate appears relatively attractive compared to many overseas markets, which should also support ongoing demand from international investors.
 
A-REIT performance has been linked to changes in bond yields. Figure 9 indicates the increase in the S&P/ASX 200 A-REIT index has been correlated with the fall in bond yields since 2011. If bond yields continue to increase from their recent lows, this is likely to limit A-REIT stock price growth.
 
Conclusion
Overall, mixed messages from today’s data for Australian commercial property. The signs of tentative price growth or stabilisation in some inflation categories may indicate stronger retail sales growth, though the upside remains limited by weak wages growth and ongoing competition in the supermarket and apparel sectors. Stronger inflation may also put upward pressure on bond yields and limit demand for Australian commercial real estate and A-REITs. However, the commercial real estate bond yield spread remains very large and Australian commercial real estate continues to look attractive compared too many overseas markets, suggesting investment demand should remain solid.


John Sears
National Director, Research
Cushman and Wakefield
Figure 1:
Consumer price inflation growth by category, annual change %
 

Source: ABS; Cushman & Wakefield
Figure 2:
Consumer price and utilities inflation, annual change %
 

Source: ABS; Cushman & Wakefield
Figure 3:
Tradeable and non-tradeable inflation, annual change %
 

Source: ABS; Cushman & Wakefield
Figure 4:
Tradeable goods inflation and the AUD/USD (inverted), annual change %
 

Source: ABS; Cushman & Wakefield
Figure 5:
Tradeable goods inflation and petrol prices, annual change %
 

Source: ABS; AIP; Cushman & Wakefield
Figure 6:
Tradeable goods inflation and retail trade, annual change %
 

Source: ABS; AIP; Cushman & Wakefield
Figure 7:
Ratio of part-time to full-time employment and wage price growth %
 

Source: ABS; Cushman & Wakefield
 Figure 8:
All property income return, 10 year bond and index bond yields %
 

Source: IPD; RBA; Cushman & Wakefield
 Figure 9:
S&P/ASX 200 A-REIT index and 10 year bonds (inverted %)
 

Source: SMH; RBA; Cushman & Wakefield
 
John Sears
National Director, Research
john.sears@cushwake.com
Dominic Brown
Head of Australia & New Zealand Research
dominic.brown@cushwake.com
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