One of Australia's best inflation forecasters says a big downside miss is coming next week

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  • Westpac Bank has an excellent track record for predicting what will be seen in Australian inflation reports.
  • It says a big undershoot is on the way next week, moving both headline and underlying inflation further away from the RBA’s 2-3% target.
  • The bank also expects Australia’s unemployment rate will rise this year while GDP growth will slow.
  • Despite that outlook, it still sees the cash rate remaining steady until at least the end of 2020. Financial markets, and an increasing number of economists, are now predicting the RBA will cut rates this year.
  • Based on public statements late last year, the RBA still sees the next move in the cash rate as likely to be higher.

When it comes to Australian inflation reports, it pays to listen to Westpac Bank. Its economics team has an excellent track record for predicting what will happen in advance.

So when it says that an ultra-weak inflation report is on the way next week, we tend to sit up and take notice. As should financial markets, given many are now flirting with the idea that the next move in official interest rates will be lower.

After crunching the December quarter data, Westpac senior economist Justin Smirk says a big downside surprise is on the way. Again.

“Westpac’s forecast for the December quarter headline CPI is 0.3% which will see the annual pace ease to 1.5% from 1.9%,” he says.

“Westpac’s forecast also takes the two quarter annualised pace down to 1.4% from 1.6%.”

For underlying inflation, of far more importance when it comes to the outlook for the RBA cash rate, Smirk says not only is the annual rate not going to move back towards the lower-end of the RBA’s 2-3% target, but it’s likely to decelerate even further.

“Core inflation is forecast to print 0.3% for the quarter, moderating the annual pace to 1.6% from 1.7%,” he says.

“The trimmed mean is forecast to rise 0.30% and the weighted median is forecast to rise 0.34%.

“The two quarter annualised pace of core inflation eases back to a very modest 1.3% from 1.5% putting the momentum in inflation well below the RBA’s target band.”

Underlying inflation is the average of the ABS trimmed mean and weighted median measures, and is seasonally adjusted unlike the headline CPI measure.

Such a result would be uncomfortably low for the RBA, leaving inflation back near the levels when it last cut Australia’s cash rate. If Smirk is correct, expect the talk of RBA rate cuts to intensify.

Following an out-of-cycle increase in variable interest rate mortgages announced my the National Australia Bank, cash rate futures now put the odds of a 25 basis point decrease in the cash rate by November this year as a two-in-three chance.

An increasing number of economists are also forecasting that the next move in the cash rate will be down, a significant shift from what was seen only six months ago.

Several mainstream forecasters such as AMP Capital, Capital Economics and Market Economics are actually calling for a series of cuts in the coming year.

While markets are flirting with the idea that the cash rate may fall to fresh-record lows this year, the RBA, at least based on public statements now several months ago, still believes the next move in the cash rate is likely to be higher.

“Members assessed that the current stance of monetary policy would continue to support economic growth and allow for further gradual progress to be made in reducing the unemployment rate and returning inflation towards the midpoint of the target,” the RBA said in December.

“In these circumstances, members continued to agree that the next move in the cash rate was more likely to be an increase than a decrease, but that there was no strong case for a near-term adjustment in monetary policy.”

The picture for the RBA

The RBA is banking upon strong, above-trend GDP growth over the next couple of years to place downward pressure on unemployment and upward pressure on wages and inflation.

However, Australian GDP growth slowed sharply in the September quarter, a theme that few expect will be reversed in the December quarter, or in the first half of this year, given a slew of weak economic indicators that have been released in recent months.

If GDP doesn’t grow above 3% both this year and next as the RBA forecast in November, it will create even greater doubt about the central bank’s inflation and unemployment forecasts being achieved.

Westpac thinks there’s little chance they will.

“Core inflation is forecast to be below the bottom of the RBA target band as moderating housing costs hold back overall inflationary pressures,” Smirk says.

“Overlay a competitive deflationary pressure in consumer goods and it is hard to see core inflation breaking much higher any time soon.”

Smirk also says the recent decline in Australia’s unemployment rate, falling to the lowest level since June 2011 in December, is likely to be reversed later in the year.

“For 2019 we are looking for a pause in the pace in employment growth due to the economic uncertainties surrounding the Federal Election at the same time as we expect to see a moderation in momentum in New South Wales and Victoria on the back of a moderation in housing activity,” he says.

“We are expecting this to slow employment growth to below the pace of growth in the labour force lifting the unemployment rate to 5.3% around mid-2019.”

Both views reflect Westpac’s view that Australian GDP growth will decelerate further in the coming quarters, leaving it shy of the 2.75% trend level where unemployment and inflation are generally stable.

While downside risks for GDP and inflation appear to be growing to the downside, Westpac has not joined the rate cut club just yet, forecasting that the cash rate will remain steady until the end of 2020 at the earliest.

Australia’s Q4 CPI report will be released on Wednesday, January 31.

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