Australia is winning the inflation fight, with the next rate move expected to be down

Inflation fell faster in the December quarter of 2023 than forecasters, the money markets and even the Reserve Bank of Australia (RBA) itself had expected, paving the way for the central bank to start cutting the cash rate this year, and possibly earlier than many had expected.

The figures mean the RBA board will almost certainly decide not to raise rates further at its first monetary policy meeting for 2024 on the 5th and 6th of February.

Perhaps, the boldest pronouncement came from former Assistant Reserve Bank Governor Luci Ellis, now Westpac’s Chief Economist.

“The data flow since November has pointed in this direction,” she wrote in an economic note to clients, “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 numbers

The Australian Bureau of Statistics (ABS) says annual inflation was at a two-year low of 4.1% during the December quarter of 2023, with the Consumer Price Index (CPI) rising just 0.6% across October, November, and December.

Major banks like the ANZ had been expecting a result of around 4.3%, while the RBA’s own forecast had predicted a much higher outcome of 4.5%.

“This data on its own would suggest that the RBA is done hiking,” Carlos Cacho, Senior Economist at investment bank Jarden, says.

“It's suggesting that goods deflation is certainly coming through.”

“If we focus on imported consumer goods, it's very much - we're seeing prices go backwards,” he told ABC News.

The more accurate quarterly inflation figures confirm the trend in the more volatile monthly CPI releases, which have shown annual inflation in Australia is now a long way from its peak of 7.8% in December 2022, thanks in large part to no less than 13 interest rate hikes from the central bank.

This has helped moderate consumer demand, probably best demonstrated by this week’s lacklustre retail trade figures for December, which showed a 2.7% month-on-month fall.

According to the ABS, the most significant price rises this quarter came from tobacco products (+7.0%), new dwellings purchased by owner-occupiers (+1.5%), domestic holiday travel and accommodation (+3.9%) and medical and hospital services (+1.2%).

Devil’s in the detail

It’s in those last three categories where any doubts about whether Australia is truly winning the war against inflation lie.

“The RBA, and (Governor) Michele Bullock, in her communications late last year, really was focusing the RBA's attention on services inflation,” Carlos Cacho says, “And there we've seen less positive progress.”

“Services inflation was steady at 1% in the quarter.”

“If in three months time we're sitting here again and services inflation is continuing to hold up at 1% a quarter and above 4% year on year, the RBA might have to think that maybe a little bit more (of an increase in interest rates) is needed.”

“A lot of that pressure on services is coming through areas that the RBA doesn't have that much of an impact on - things like insurance premiums, which are rising at the fastest pace in years at over 16%; it's rents which, even with the effect of Commonwealth Rent Assistance, are still rising at 7% and probably going to remain pretty close to double digits for most of the next two years,” Mr. Cacho says.

The ABS itself highlighted high inflation in the “non-tradables” sector, which includes goods and services that are mostly influenced by domestic factors.

“Annual inflation for non-tradables remains elevated at 5.4% due to price rises for new dwellings, rents, insurance and electricity,” the official statistician says.

The wrap-up

Overall though, most analysts believe the December quarter inflation numbers show that the RBA should consider it’s done enough on the interest rate front to return inflation to its target band of 2-3% by the end of next year.

“The more inflation comes in under expectations, the firmer the case for interest rates remaining on hold next week, and coming down later this year,” says CoreLogic’s Head of Research, Eliza Owen.

Ms Owen points out that housing makes up around 22% of the goods and services measured to calculate the ABS Consumer Price Index numbers.

“Housing contributes a lot to high inflation through rent paid and the cost of new dwellings, but even these indicators are moving in the right direction”, she says.

“The economic pain Australian households are feeling is working to unwind inflation, and firms up the case for interest rates to start falling sometime this year.”

The question now for CoreLogic’s Eliza Owen and other analysts is when those interest rate cuts may come.

Financial markets have already priced in at least one 25 basis point interest rate cut from around August this year and another from around December.

But with headline inflation coming in lower than expected and weak retail trade and consumer confidence, ANZ economist Catherine Birch observed that “risks might be starting to skew toward an earlier commencement of rate cuts”.

In the immediate aftermath of the release of the inflation numbers, the financial markets priced in a 96% chance of no change in the cash rate and an outside 3% chance that rates would actually be cut at next week’s RBA’s February meeting.