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RBA rate cut odds strengthen as inflation remains ice-cold

  • A near-term RBA rate cut is now a real possibility following the release of another weak Australian inflation report on Wednesday.

  • Consumer price inflation (CPI) was unchanged in the March quarter and rose by just 1.3% over the year. Sharp falls in fuel prices and housing costs drove the flat outcome, offsetting higher costs for vegetables, fruit and education.

  • Regardless of economic conditions or unemployment levels, inflation was weak in all Australian capital cities over the year.

  • Underlying CPI grew by just 1.42% over the year, the equal-lowest rate on record. The RBA's medium-term underlying inflation target is 2% to 3%.

  • Right now, underlying inflation is moving further away, rather than closer to, the RBA's mandated level.

  • When underlying inflation was this weak in the past, the RBA cut official interest rates.

  • Financial markets see a 25 basis point rate cut next month as a two-in-three chance. A full cut is priced in by July. A second 25 basis point cut is also priced in by February next year. That would leave Australia's cash rate at just 1%.

Australian inflationary pressures weakened further in the March quarter, increasing the odds the Reserve Bank of Australia (RBA) will cut official interest rates in the months ahead.

According to the Australian Bureau of Statistics (ABS), headline consumer price inflation (CPI) was unchanged in the three months to March, seeing the annual increase slow sharply to just 1.33%, down from 1.78% in the year to December last year.

Markets had been expecting a quarterly increase of 0.2% and year-ended rate of 1.5%.

Image: BI

"The [unchanged reading] was a result of price rises in a number of goods and services being fully offset by a number of price falls," the ABS said. "This was consistent across most of the capital cities."

The ABS said the most significant price rises during the quarter came from vegetables, secondary education and motor vehicles.

"Drought and adverse weather conditions continue to reduce the supply of a selection of fruits and vegetables," it said.

Those gains were completely offset by a steep decline in automotive fuel prices which slumped by 8.7% from three months earlier. Prices for domestic and international holiday expenses also fell steeply during the quarter.

"Lower world oil prices at the end of 2018 saw automotive fuel prices fall 6.1% in January, before rising in February and March," the ABS said.

Those gains have since continued in the June quarter, pointing to rebound in these categories in the next CPI report.

Image: ABS

By source of inflation, tradable prices slumped by 0.6% during the quarter, trimming the increase over the year to just 0.4%. Tradable prices are influenced by overseas factors. The weakness in the March quarter was largely driven by weaker fuel prices.

Non-tradable prices -- those largely determined by domestic influences -- rose by 0.3% during the quarter and by 1.8% over the year. Non-tradable goods and services prices account for over 60% of the weighting in the ABS inflation basket.

The CPI figure is calculated using price movements in a set basket of goods and services commonly purchased by metropolitan households.
Individual items fall into 11 broader categories, and are weighted based on estimated expenditure by households.

By capital city, inflation over the year ranged from just 0.4% in Darwin to as high as 2.1% in Hobart. In Sydney, Melbourne and Brisbane, Australia's most populous cities, paltry increases of just 1.3%, 1.2% and 1.5% were reported.

No matter where you live, inflation was very weak over the past year, regardless of prevailing economic conditions nor the level of unemployment.

Image: ABS

Underlying inflation -- of more importance when it comes to the outlook for monetary policy settings from the RBA -- rose by 0.19% during the quarter after seasonal adjustments, a result well below expectations for a larger increase of 0.4%.

Underlying inflation is the average of the trimmed mean and weighted median inflation figures released by the ABS.

It was the weakest quarterly increase on record, surpassing the previous record set in the March quarter of 2016. Back then, such was the weakness in core inflation, it was enough to prompt the RBA to cut rates not once but twice within the next three months.

The big quarterly undershoot saw the annual rate fall to just 1.42%, well below the bottom of the RBA's 2-3% medium-term target.

Underlying inflation has now remained below the RBA's target level for over three years. Not only that, it is now clearly decelerating away from the RBA's mandated level, increasing the odds the bank will cut Australia's cash rate in the months ahead, potentially as soon as next month.

Image: BI

"Today’s data will put increasing pressure on the RBA to cut interest rates," said Ben Udy, Economist at Capital Economics.

"Our expectation has been that the Bank would wait for further weakness in economic activity and the labour market before cutting rates in August, but the outlook now is eerily similar to early-2016 when the Bank cut rates on the back of weak inflation data despite steady improvements in the labour market.

"The risks are becoming increasingly skewed towards an earlier rate cut, perhaps as soon as May."

In early February, the RBA forecast that trimmed mean inflation -- its preferred underlying measure of price pressures -- would grow by 1.8% in the year to June this year.

At 1.6% in the year to March, this forecast is now looking increasingly unlikely to be achieved, pointing to a further downgrade to the bank's next set of forecasts that will be released in early May.

Previously, the RBA stated that a lack of progress in returning inflation to its target, along with a sustained increase in Australia's unemployment rate, were two triggers that could warrant a further reduction in Australia's cash rate.

Earlier this month, the bank's board doubled down on that view, acknowledging "a decrease in the cash rate would likely be appropriate" should inflation remain weak and unemployment start to lift.

With inflation showing few signs of picking up, if any at all, and with sluggish economic growth pointing to the risk that unemployment will start to increase in the months ahead, the RBA has been provided with a potential trigger to lower official interest rates again.

Even with unemployment continuing to sit near the lowest level in eight years, that's done very little to boost worker wages and economic growth, two factors the RBA were relying upon to lift inflation back to within its inflation target.

Financial markets now see a 25 basis point rate cut from the RBA on May 7 as a two-in-three chance, with those odds moving beyond 100% by the time the RBA meets in June.

A further 25 basis point reduction -- taking the cash rate to just 1% -- is also fully priced to occur by February next year.

After keeping Australia's cash rate steady at 1.5% since August 2016, it now appears highly likely that Philip Lowe will soon deliver his first monetary policy change as RBA governor.

"The RBA should cut rates when they meet in May, rather than waiting a few months for employment growth to converge with the myriad of weak economic measures," said Callam Pickering, APAC Economist at jobs specialists Indeed.

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