Australia's Core Inflation Eases, Fueling Rate Cut Expectations

Australia's trimmed mean inflation gauge, a key measure of underlying inflation, moderated in Q4 2023 to 3.2%, below market expectations of 3.3%. This eased inflationary pressure signals a potential interest rate cut in February.

The Reserve Bank of Australia (RBA) closely monitors core inflation, excluding volatile items, as it remains above the target band of 2-3%. Despite government subsidies suppressing headline inflation, trimmed mean CPI has not met this target since late 2021.

The data release caused the Australian dollar (AUD) to weaken, while yields on three-year government bonds fell by 7 basis points. Stocks advanced as money markets increased bets on a rate cut next month to over 90%.

Economists believe today's data strengthens the RBA's belief that inflation is on track to stabilize within the target range. The central bank indicated a dovish shift at its December meeting, considering scenarios for rate cuts or maintaining current restrictive levels.

However, the RBA board remains cautious due to elevated annual services prices, particularly in rents, medical services, and insurance. Despite non-discretionary items seeing a 0.5% quarterly decline, discretionary items still lead in inflation, indicating sustained consumer spending and a strong labor market.

The RBA acknowledges the risk of rising consumption and a tight labor market hindering its efforts to lower core inflation. The upcoming election could further prompt spending initiatives, potentially exacerbating inflationary pressures.

Australia's easing cycle differs from many developed economies, as the RBA opted for a lower peak rate in 2022-23 to mitigate the impact on heavily indebted households. The Fed, set to announce its decision later today, is expected to maintain rates.

The RBA's baseline scenario projects unemployment to peak at 4.5% this year. Its November forecast anticipated trimmed mean inflation to reach 3.4% by the end of 2024 and gradually decline to the upper limit of the target by mid-2025. Updated forecasts will be released on February 18 alongside the rate decision.

Other highlights from the inflation report include:

* Education, health, and insurance sectors contributed significantly to inflation gains.
* Non-tradable prices, influenced by domestic factors, rose by 3.1%.
* Tradable prices, affected by the currency and global factors, increased by 1.1%.