Australia's Core Inflation Slows, Sparking Rate Cut Bets
Australia's trimmed mean inflation rate, which excludes volatile items, eased to 3.2% in the three months ending December 2024, below the expected 3.3%. On a quarterly basis, core consumer prices increased by 0.5%, lower than the forecast 0.6%.
This positive inflation news has led to the Australian dollar weakening and a decline in the yield on three-year government bonds, indicating market expectations of an interest rate cut in the near future. Money markets now see a better than 90% chance of a February rate cut.
Several economists, including those at Westpac Banking Corp., Royal Bank of Canada, TD Securities, and AMP Ltd., have revised their predictions for the Reserve Bank of Australia's (RBA) first rate cut to February. Goldman Sachs, which previously expected cuts in February and May, now anticipates an additional reduction in April.
"CPI has been the decisive factor," said Luci Ellis, chief economist at Westpac. "Housing-related inflation suggests that domestic price pressures are fading faster than the RBA feared."
The inflation data aligns with the RBA's belief that inflation is on track to return to its 2-3% target within a reasonable timeframe. At their December meeting, policymakers considered scenarios that could lead to interest rate cuts.
"Today's data cements a February rate cut," said Diana Mousina, deputy chief economist at AMP. "Disinflation in areas like rents and dining out indicates that the period of goods inflation is over."
Despite the encouraging inflation report, the RBA may proceed cautiously due to ongoing elevated services prices. Annual services inflation remains high at 4.3%, led by rents, medical services, and insurance.
The inflation report also highlights a divergence between discretionary and non-discretionary spending. Non-discretionary goods and services fell 0.5% during the quarter, while discretionary rose 1.1%. This suggests that consumer spending is rebounding, potentially mitigating inflation pressures.
The RBA will face additional challenges as Australia prepares for elections, where both major political parties may propose spending initiatives that could counter inflation efforts.
Australia has taken a more cautious approach to monetary policy easing compared to other developed nations. The Federal Reserve is expected to announce a decision on interest rates later today, but is not anticipated to make any changes.
The RBA's baseline scenario predicts unemployment to rise to 4.5% this year, up from 4% currently. The central bank forecast trimmed mean inflation to end 2024 at 3.4%, before easing to the top of the inflation target by mid-2025. Updated forecasts will be released on February 18, along with the next rate decision.