Australia’s Cooling Inflation and Implications for Interest Rates
Australia’s economic landscape witnessed notable changes as core inflation cooled more than anticipated in the last quarter of 2024, prompting expectations of an impending interest rate cut from the Reserve Bank of Australia (RBA). According to a Bloomberg report dated January 29, 2025, the annual trimmed mean measure of consumer prices, which excludes volatile items, recorded a 3.2% increase in the three months leading to December. This figure fell short of the anticipated 3.3% rise, while quarterly growth in core consumer prices was reported at 0.5%, below the expected 0.6%.
This shift in inflation metrics has had immediate repercussions in the financial markets. The Australian dollar experienced a decline, and yields on policy-sensitive three-year government bonds dropped by as much as 7 basis points. Consequently, stock markets reflected a bullish sentiment as money markets recalibrated their expectations for a rate cut in February, marking it with a probability exceeding 90%.
Diana Mousina, deputy chief economist at AMP Ltd., underscored that the latest inflation data strongly supports a February rate cut. She noted that the rationale for reducing rates outweighs that of maintaining the current rate. Her analysis highlighted a significant deceleration in inflation across several sectors, including housing, healthcare, and dining, suggesting that the phase characterized by rising goods inflation is concluding. Nevertheless, services inflation continues to pose a challenge.
The current inflation trends are reinforcing the RBA’s commitment to aligning inflation rates with targeted goals. At its last meeting in December, the RBA adopted a dovish stance, contemplating either a reduction in rates or keeping them steady at the current high of 4.35%, which represents the highest level in 13 years. Economists like James McIntyre expect the RBA to amend its inflation forecasts in anticipation of a forthcoming easing cycle.
Despite the cooling inflation, the RBA is expected to approach its upcoming meeting cautiously. Annual service prices remain elevated at 4.3%, propelled by costs associated with housing and healthcare services. Interestingly, data revealed that non-discretionary goods prices experienced a rare decline of 0.5% in the latest quarter, whereas discretionary items saw a 1.1% increase. This unusual scenario highlights strong consumer spending habits.
Insights from IndexBox suggest that a robust labor market and increasing consumer expenditures could sustain inflationary pressures. The RBA continues to express concerns regarding the synergistic effects of renewed consumption and solid labor market conditions that may stymie ongoing inflation reduction efforts. Economist Sean Langcake emphasizes the necessity for the RBA to remain vigilant as the economy nears full capacity. Furthermore, he cautions that the phase-out of certain subsidies may trigger a resurgence in headline inflation.
The context of upcoming political elections poses additional fiscal considerations, as political parties may resort to substantial spending initiatives to garner voter support. In its strategy against inflation, the RBA has adopted a comparatively lower peak interest rate relative to other central banks worldwide, mindful of households burdened by high mortgage repayments.
Australia’s distinct economic approach to easing contrasts sharply with the more aggressive rate cuts seen from counterparts like the Federal Reserve. Projections indicate an unemployment peak of 4.5% in Australia this year (up from the current rate of 4%). The RBA is poised to update its economic forecasts on February 18, with expectations that the trimmed mean Consumer Price Index (CPI) will reach 3.4% by the end of 2024, before stabilizing within target ranges by mid-2025.
In conclusion, Australia’s cooling inflation sets the stage for potential monetary policy shifts aimed at bolstering economic stability. The RBA is poised to navigate the delicate balance between managing inflation pressures and supporting consumer spending in a complex economic environment marked by strong labor markets and upcoming political challenges. As the situation evolves, all eyes will be on the February meeting as a harbinger of the RBA’s future actions.
