Inflation result and global woes possibly put more pressure on RBA to cut rates

A modest increase in underlying inflation and the decision by the IMF to cut its global growth forecasts have increased the likelihood of the RBA cutting interest rates next month. 

Seasonally adjusted CPI rose 0.2% for the quarter – in line with economists’ estimates to be up 3% year-on-year. 

Fruit prices fell furthest during the quarter, down 13.4% due to a sharp drop in the cost of bananas, while costs also dropped for pharmaceuticals, vegetables and electronics. Domestic holiday travel, beer, telecommunications and rents all increased.

Underlying inflation increased by 0.55% (weighted mean of 0.5%, trimmed mean of 0.6%) in the December quarter to an annualised rate of 2.6%. Headline inflation for the quarter was 3.1% just outside the RBA’s inflation target range of between 2% and 3%, but below estimates of 3.3%.

RP Data’s Tim Lawless believes the inflation figure is good news for interest rates as does Channel Nine finance editor Ross Greenwood. 

“Headline inflation steady. Seasonally adjusted 0.2%. Lock in rate cut Tuesday week,” tweeted Greenwood. 

Financial commentator and TV host David Koch tweeted: “Inflation well under control so Reserve Bank should cut rates in 2 weeks.” 

However, economists are more divided on what the inflation numbers mean for interest rates. 

Rismark International and Yellow Brick Road director Christopher Joye says markets reacted to the inflation results with “big disappointment”. 

“The Aussie dollar jumped from US1.047 before the print to US1.052 after. More tellingly was the reaction of Australian government bond futures. The benchmark three-year government bond contract immediately plummeted 10 points from 96.74 to 96.64 as traders priced in higher long-term interest rates. The 30-day interbank futures contract also substantially reduced the probability of a rate cut in February, although it is still pricing in a better-than-evens chance,” he says. 

According to Joye, the February rate call is a line ball call, with the risk being “that the fourth-quarter [core inflation data] also gets revised up, and the numbers start looking a little ugly for Australia's central bank”.

Macquarie senior economist Brian Redican says the latest figures suggest inflation is “well contained” and will not surprise the RBA.

A rate cut, Redican says, will allow the RBA to “take out more insurance about the weakening global outlook; they can be more worried about those soft employment numbers”.

Rochford Capital currency director Derek Mumford says there might be a rate cut in February but it could be the end of the rate cutting cycle due to the increase in core inflation.

“That would suggest that in the short term interest rates can come down but perhaps the RBA will be less keen to cut rates sharply."

Ahead of the announcement Craig Michaels, senior economist at ANZ, said a 0.5% quarterly increase in underlying inflation would lend further support to its view “that the RBA has scope to further reduce rates, given the continued risk of European financial market dislocation, as well as a cyclical slowdown in Chinese growth and further labour market softness”.

The RBA board will also take note of the International Monetary Fund’s decision to cut its global growth forecast from 4% to 3.25% for 2012 principally due to a continued deterioration the Eurozone. This follows on from the World Bank cutting its economic growth forecasts to 2.5% in 2012 and 3.1% in 2013 – well below June 2011 forecasts of 3.6% growth for each year.

The IMF expects the eurozone to fall into a mild recession in 2012 after the crisis entered a “perilous new phase” toward the end of last year, affecting other parts of the world including the United States, emerging markets, and developing countries.

Olivier Blanchard, the IMF’s economic counsellor, says the global growth outlook is mediocre and could be worse. 

Speaking in Washington, Blanchard says “the world recovery, which was weak in the first place, is in danger of stalling”. 

“The epicentre of the danger is Europe, but the rest of the world is increasingly affected,” he says. 

Mortgage broker Loan Market says the RBA will need to reduce the official interest rate by at least 0.5 percentage points next month to pressure major banks into passing on reductions to customers.

Loan Market spokesman Paul Smith says the big banks have all indicated they might not be able to match a 25-basis-points cut to the cash rate should the central bank cut rates on February 7.

“The RBA will have to go hard with at least a 50-basis-point reduction at their next meeting and the latest official figures showing a lower-than-expected 3.1% annual inflation rate and prospects of rising unemployment support the need for a cut,” he says.

The major banks are coming under pressure from the IMF to raise their capital reserves as a buffer to a possible second GFC – a move that has been rebuffed by the Australian Bankers Association, which says it will force the banks to raise mortgage rates if implemented.

The ABA says the banks are already well capitalised and already implementing requirements under Basel III global banking reforms to hold higher levels of cash.

Holding higher levels of cash reserves would force the banks to ration credit and push up interest rates, the ABA has warned.