RBA rate cuts imminent, probably starting in May: Shane Oliver

RBA rate cuts imminent, probably starting in May: Shane Oliver
RBA rate cuts imminent, probably starting in May: Shane Oliver

EXPERT OBSERVATION 

The Australian March quarter Consumer Price Index showed flat headline inflation over the quarter and annual inflation falling to 1.3%, missing expectations of a 0.2% quarter on quarter rise.

The bigger downside surprise came from weaker underlying inflation.

Underlying inflation, as measured by the trimmed mean and weighted median, averaged 0.2% over the quarter and 1.4% over the year which missed consensus expectations of 0.4% quarter on quarter and 1.7% year on year.

The RBA uses underlying inflation as the best guide to fundamental price trends in the economy because it excludes volatile price changes.

Inflation continues to track below the RBA’s 2-3% target band (see chart below) and the central bank is likely to revise down its inflation forecasts.

RBA rate cuts imminent, probably starting in May: Shane Oliver

Source: ABS, AMP Capital

In the March quarter, the largest price rises came from the usual seasonal sources (education and medical services), a lift in motor vehicle prices and a rise in food prices (particularly vegetables). But these were offset by price falls for fuel (given a sharp decline in petrol prices) and domestic and international holiday travel (a seasonal effect). 

While the petrol price has since bounced back the lack of underlying pricing pressure in the economy is evident in pricing weakness across areas like clothing, rents, household equipment and services and communications. The weakness in underlying inflation shows that businesses are still finding it challenging to lift prices in the face of ongoing spare capacity, intense competition and weak demand.

Other measures of underlying inflation also remain very low. Inflation excluding food and energy, which is the US core measure of inflation, is running at just 1.3% year on year (in the US its running at 2% year on year) and inflation in the private sector of the economy (excluding volatile items) is at 1.4% year on year (as measured by the “market goods and services ex volatiles items” index).

Implications

The weakness in Australian inflation confirms the spare capacity remains significant in the economy. With GDP growth expected to remain low in 2019 – at around 2.3% - spare capacity and weak demand will continue to put downward pressure on prices and wages.

The March quarter inflation data missed the RBA forecasts (see chart below), which continues the trend over the past few years of the RBA overestimating inflation, and means that the central bank is likely to downgrade its inflation forecasts yet again next month. The longer inflation undershoots the 2-3% target, the greater the risk that the target will lose credibility. This in turn will see low inflation expectations become more entrenched making it in turn even harder to get inflation back to target. 

Lowering the target would be a huge mistake and would see inflation targeting lose all credibility and only lock in low inflation (and the risk of deflation) for longer.

RBA rate cuts imminent, probably starting in May: Shane Oliver

Source: ABS, AMP Capital

We have been looking for two rate cuts this year since last December and had thought that the RBA would wait till after the election before starting to move. However, with underlying inflation coming in much weaker than expected our base case is now that the first cut will come next month, with the RBA likely to conclude that it’s too risky to wait until unemployment starts to trend up.

Shane Oliver is Head of Investment Strategy and Chief Economist AMP Capital.

Diana Mousina is an Economist at AMP Capital

Tags: 
Shane Oliver Inflation

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