Inflation in the June quarter was in line with our expectations, and a shade below on some key measures. With the disinflation on track, we affirm our view that rates are on hold until November and likely to decline from then.
Inflation in the June quarter was broadly in line with our expectations, and a shade below them on some crucial underlying measures. Headline CPI inflation was as expected at 1% in the quarter, while the key trimmed mean measure of trend inflation was a bit below at 0.8% versus our expectation of 0.9%. On a year-ended basis, this represents a small increase in headline inflation (from 3.6% to 3.8%), albeit one that was in line with the RBA’s own forecasts. The RBA will look through the base effects driving this and will note that there are no signs of upward momentum in the trimmed mean or monthly outcomes.
Monetary policy decisions are not determined by a single number. As Deputy Governor Hauser pointed out recently, labour market, retail sales, building approvals and other key data have all been released in the lead-up to next week’s RBA Board meeting. None of these provided much of a fresh signal, however, rendering the CPI release pivotal.
The below-consensus result cements our expectation that the RBA Board can remain on hold for the time being. As we have previously flagged, another quarter of inflation data should be enough to convince the RBA Board that disinflation is on track and that inflation will be back into the target range on the desired timetable. That would lead the Board to the conclusion that monetary policy does not need to be as tight as it currently is for much longer.
Recall that the RBA regards the current stance of monetary policy as tight. If the cash rate remained where it is indefinitely, inflation would ultimately decline below the 2–3% target range. Monetary policy operates with a lag, so rate cuts need to start ahead of inflation reaching target. If the Board waits too long, it will risk undershooting the target for no benefit. So rate cuts are likely in the near future, provided inflation continues to traverse the trajectory that the RBA Board is seeking to achieve.
We also note the recent comforting inflation experience of other countries. And, as we have argued previously, it is hard to point to anything that would cause Australia to have a qualitatively different disinflation experience. This is not 2016, when the RBA and Federal Reserve were moving in opposite directions. Back then, the US economy was benefiting from the end of the post-GFC headwinds; by contrast, Australia was navigating the unwind of the mining investment boom. The forces driving economic outcomes were completely different across the two economies.
This time around, Australia and peer economies are all facing a more-or-less common shock. Domestic demand growth is weak, and disinflation has been especially pronounced in discretionary spending categories. There are bumps along the way, including the one seen earlier in the year. And there are some home-grown issues in the housing complex, with inflation in both rents and construction costs likely to remain elevated for some time. Fundamentally though, Australia and its peer economies are seeing the pandemic-era, supply-driven inflation surge unwind, and this is running its course.
Given the sub-consensus inflation outcome and the run of other data confirming that domestic demand growth is soft, we affirm our November call for the first rate cut, with more conviction than previously. We note, however, that the Board is not in a hurry to cut given lingering inflation risks. It is plausible that the Board will retain the ‘not ruling anything in or out’ language in its post-meeting communication. We also anticipate that rates will decline only gradually; we currently project that the RBA cash rate target will fall to 3.1% by end-2025, and this is likely to be the trough. In 2026 and beyond, a period of above-average growth can be anticipated, so interest rates are unlikely to fall further from there.
, albeit one that was in line with the RBA’s own forecasts. The RBA will look through the base effects driving this and will note that there are no signs of upward momentum in the trimmed mean or monthly outcomes.){kind=link}