The data flow since November has pointed in this direction, and today’s CPI release seals the deal: the RBA will keep the cash rate on hold next week, and it is unlikely to raise rates further this cycle
The data flow since November has pointed in this direction, and today’s CPI release seals the deal: the RBA will keep the cash rate on hold next week, and it is unlikely to raise rates further this cycle.
At its previous forecast round in early November, the RBA was expecting both headline and trimmed mean inflation to be 4.5% over calendar 2023. The implied forecast for the quarter was around 1% in both cases. The actual result was 0.6% in the quarter and 4.1% over the year for headline CPI inflation and 0.8% and 4.2% for the bellwether trimmed mean measure.
The detail was slightly below our expectations, and noticeably below the RBA’s. Domestic inflation is now clearly coming down. Market services inflation has dropped significantly. The monthly CPI indicator for December was distorted by base effects involving holiday travel, but measures excluding this are now running in the low 4% range and clearly heading down.
These inflation outcomes need to be seen in the context of the soft flow of data since November. In particular, the September quarter national accounts were noticeably weaker than the RBA expected. This cast doubt on the Board’s assessment that domestic demand remained resilient. Subsequent data on retail spending and the labour market has only reinforced those doubts. The squeeze on household incomes from high inflation and a rising tax take, as well as higher interest rates, has continued. Consumer spending and sentiment are both soft; investment spending did not hold up as the RBA expected in the September quarter national accounts. As Westpac Economics colleague Senior Economist Andrew Hanlan noted earlier today, business investment is likely to stall this year.
Some of the upside risks the Board minutes had been calling out in recent months have not come to pass. The increase in housing prices, mentioned in the December 2023 minutes, is now losing steam, especially in Sydney and Melbourne. The concerns raised the same month that falling inflation would boost households’ purchasing power – and so spending – have been ruled out by the subsequent release of the September quarter national accounts. That national accounts release also showed that the RBA’s concerns about falling productivity had been somewhat overblown. As we had predicted ahead of the release, productivity ticked up in the September quarter and the history was revised up.
Despite this, the RBA and its Board have been sensitive to the risks that inflation would not come down as quickly as they want. In their November forecast round, they had pushed out their expectations for the date that inflation would return to target to end-2025, and they were clearly uncomfortable about this. They had also concluded that inflation was increasingly driven by domestic factors: a conclusion that, we believe, did not adequately allow for the effects of displaced demand on some prices – the “other fruit” problem. In the minutes following that meeting, the Board noted “lowering inflation from its current level would require growth in aggregate demand to remain subdued”. In our view, aggregate demand is already subdued and does not need further policy tightening to keep it there.
Another concern of the RBA Board was the possibility that inflation expectations could lift. While the usual measures of the expectations of consumers and market participants are a little higher than pre-pandemic, they are still well within the target range. In any case, the pre-pandemic period was characterized by inflation being below the target. Some increase from those levels is therefore entirely consistent with the RBA achieving its goals.
Given these concerns, the RBA Board therefore is unlikely to rule out further rate increases entirely in their post-meeting communication. But the case to raise rate from here is steadily losing traction. We expect that over coming months, further declines in inflation and soft outcomes in the real economy will give the Board enough confidence that inflation will return to target on the desired timetable. They will therefore have scope to reduce some of the current restrictiveness of policy. We continue to expect the first rate cut no earlier than September.
In articulating their decision, the Board will have the advantage that the Bank’s forecast horizon will roll forward to mid-2026 this round. It is therefore entirely possible that the staff forecasts can now be shown with inflation ending the period at 2½%, the midpoint of the 2–3% target range. Specifying when inflation would reach that midpoint was one of the recommendations of the RBA Review.
Also changing following the RBA Review recommendations are some of the arrangements around the Board meeting itself and the release of the Statement on Monetary Policy (SMP). The meeting will now take place over two days. This will give the Board more time to discuss the outlook and risks, and the staff more time to present scenarios and other analysis that could not easily be fit into the agenda in the previous shorter-format meeting. It will allow also allow the Board to review both the media release and Overview of the SMP ahead of the policy announcement. The SMP can therefore now be released on the same day as the policy announcement. Along with the Governor’s media conference the same afternoon, this will provide the RBA with more scope to explain its decision.
