It’s on: the better-than-expected inflation data tips the balance back to the February move we had previously expected. RBA’s view of the economy will need to pivot further.
Normally it should not come down to one number. This round, however, the CPI has been the deciding factor because the message from other available data has been so mixed. With trimmed mean inflation at 0.5% in the quarter (3.2%yr), we have just enough evidence to conclude that disinflation has proceeded faster than the RBA expected, so the Board will have the required confidence to start the rate-cutting phase in February.
When we changed our call back in November to a start date of May 2025, we nonetheless assessed that a February move could not be ruled out. It was a matter of what was the most likely outcome, not what the only possible outcome was. The better-than-expected inflation data tilts the balance of probabilities back in February’s favour.
In addition to the trimmed mean outcome (Westpac had a ‘skinny’ 0.6%, while the actual outcome was 0.5%), we see encouraging signs in housing-related inflation suggesting that the momentum in domestic price pressures is fading a bit faster than the RBA feared. Both rents and home-building costs have decelerated noticeably in recent months, and not just because of government cost-of-living support.
As noted, the rest of the data flow had not provided a clear steer either way. Domestic demand growth has disappointed, with consumers spending less of the Stage 3 tax cuts than had been widely assumed. Wages growth and other measures of labour costs have also undershot the RBA’s forecasts for late-2024 outcomes (though not our own).
Against that, the labour market has been more resilient than we or the RBA expected. At 4%, the unemployment rate in the December quarter was 0.3ppts below the RBA’s November forecast. Other indicators such as job vacancies and business surveys implied that the labour market had not eased at all in second half of 2024. Average hours worked painted a somewhat softer picture, but this was matched by an unwind in hours offered as cost-of-living pressures eased. The number of people reporting being underemployed therefore fell. The RBA already viewed the labour market as being tighter than full employment, and the recent wages data would not have induced enough of a downward revision to its assessment of the unemployment rate consistent with full employment to bridge the gap.
While we do not regard recent exchange rate movements as particularly consequential for the RBA decision, the prospect of more volatility here and in financial markets more broadly could have been a reason to delay and wait for more information.
In the end though, the good news on inflation beats the stronger news on the labour market. Recall that the RBA’s November forecasts had trimmed mean inflation at 3.4% and an unemployment rate of 4.3% for the December quarter of 2024. The 0.2ppt downside surprise on trimmed mean inflation outweighs the 0.3%pt surprise on the unemployment rate.
Finally, there is the question of timing and tactics. Contrary to the speculation seen occasionally, the RBA Board has historically set policy according to the demands of its mandate and its assessment of the economy without political considerations. Elections or other political events do not generally influence the timing of rate moves. This time, though, the forthcoming change of the make-up of the Board could create some awkward optics around timing. If the current Board held rates steady in February and then the revamped Board cut rates in April, it would look like the government ‘stacked’ the Board to get the desired result. This is one of the reasons why we focused on February and May in our assessments. So there is an argument that the current Board will opt to get on with it rather than get caught up in the politics of the situation.
We are also mindful that moving now would represent a further pivot in the RBA’s view of the economy, following the pivot at the December meeting. We therefore cannot completely rule out that the Board (and the staff) dig in on their assessment that the demand is still outstripping supply, and keep rates on hold. The run of inflation data of late makes such an assessment even harder to justify, though.
Looking beyond the next meeting, we see the RBA as remaining data-dependent from here and not in a hurry to move further. Conditional on further declines in inflation and some softening in the labour market, we see cuts in May, August and November, taking the terminal rate to 3.35%. This is in effect a reversion to our earlier call, now that it has become clearer that the economy is evolving broadly in line with our forecasts, and not the more hawkish view of domestic cost growth that would have led to further delays.
