Inflation data makes a mockery of RBA's interest rate forecasts
It is increasingly clear that the next move in interest rates is set to be lower.
The latest CPI figures are out and it’s more good news, with inflation on track to fall back to the Reserve Bank’s (RBA) target about a year before the current RBA forecasts.
The annual inflation rate surprised the markets and the RBA by holding steady at 3.4 per cent in February.
An annual reading below 3 per cent looks set to be hit in the coming months.
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Solid price increases of 5 per cent or more in the past year for tobacco, insurance and financial services, bread and cereals and education, were offset in part by falling prices for meat and seafood, fruit and vegetables, gas and other household fuels, and holiday travel and accommodation.
Inflation peaked at 8.4 per cent in December 2022 and has progressively fallen on the back of the weaker domestic economy, a slowing in global growth and the cumulative effect of the 425 basis points of interest rate increases between May 2022 and November 2023.
The monetary policy outlook will be driven by inflation. That is the core target of the RBA, along with a goal of full employment.
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It is increasingly clear that the next move in interest rates is set to be lower. RBA governor Michele Bullock did not rule out such a move when she gave her press conference last week.
The timing of the first cut in this cycle is open to debate.
The futures market is fully embracing the scenario of the trend to lower inflation, to the point where it is set to return to the RBA’s target of 2-3 per cent.
This is why there are three 25-basis-point interest rate cuts expected between the middle of 2024 and the second half of 2025.
This looks to be a reasonable expectation for interest rates, although the extended and deeper weakness in the economy, if sustained, will see earlier and more aggressive rate cuts than are currently priced in.
In other words, if inflation falls by a greater amount than the RBA is assuming, the rate-cutting cycle will be larger than currently expected.
The next inflation data - both for the month of March and the comprehensive March quarter - are released on April 24. That will be a critical day for those interested in the outlook for official interest rates.