The timing of the first rate cut - and how many will follow - is open to debate and will depend, critically, on the path of inflation and unemployment through 2024. But the recent news is pointing to lower rates.
The all-important inflation data, which was behind the Reserve Bank’s (RBA) decisions to lift interest rates aggressively in 2022 and 2023, is back on track. It's now clear, even to the RBA, that annual inflation has been in free-fall since the peak at the end of 2022.
Using the monthly data, annual inflation slumped to 3.4 per cent in December 2023, down from the 8.4 per cent peak in December 2022. In quarterly terms, inflation has dropped to 4.1 per cent, down from the peak of 7.8 per cent in the December quarter of 2022.
The inflation rate will track into the RBA’s 2-3 per cent target range in the not-too-distant future and this will open the door for interest rate cuts. The RBA will release its updated forecasts next week with its Quarterly Statement on Monetary Policy.
These forecasts will take account of the inflation update and other economic developments in recent months, all of which have been unambiguously skewed to the downside.
Also by the Kouk:
The retail trade data for December were, frankly, horribly weak. Retail spending fell by a huge 2.7 per cent, more than unwinding the “Black Friday” sales boost, which was just 1.6 per cent.
While the monthly data are volatile, householders are responding to cost-of-living pressures, the cashflow effect of higher mortgage interest rates, and the early signs of a weakening in the labour market.
In real per-capita terms, retail spending is down a staggering 6.5 per cent since the end of 2022, something akin to a deep retail recession.
Tough economic times ahead
While the economy had to slow to get inflation down, it is increasingly clear the risks are building for an overshoot towards a hard landing. Tough economic times, in other words.
This hard-landing scenario is getting credence with the labour force data, which confirmed a slump in full-time employment and hours worked in the latter part of 2023. The unemployment and underemployment rates are trending higher and job vacancies are also falling.
The economic outlook has moved to one where annualised GDP growth will be 1 per cent or less, inflation will keep falling and the unemployment rate will keep rising and pass 4.5 per cent before reaching a peak.
Forecasting the timing for lower interest rates is always a challenge, particularly when the RBA has such a poor record hitting its inflation target over the past decade. The only way to have a good take on the RBA in that time is to forecast a policy mistake!
There is some optimism that the still-new RBA senior management and objectives lead to a better implementation of monetary policy. Based on that, the first rate cut in the cycle will be on the agenda at the March and May board meetings.
The meeting on May 7 will have access to the March-quarter inflation data, which will be available just before that meeting. So, the RBA may want to see that before starting rate cuts.
Don’t just take my word for it - investors and money markets are now expecting at least two interest rate cuts in 2024, with further rate reductions in 2025. If they are right, expect interest rates to fall by a total of about 1 percentage point in early 2025, something that would lead to a significant abatement in cost-of-living pressures.