Australian inflation look set to weaken further, providing a potential trigger for the RBA to cut rates

SERGEI ILNITSKY/AFP/Getty Images
  • Australian inflation has been weak for several years.
  • Economists expect it weakened further in the March quarter of this year.
  • Core inflation is expected to move further away from the RBA’s 2-3% target.
  • The RBA has nominated a lack of progress in returning inflation to its target as one catalyst that may warrant an interest rate cut.

Australian inflationary pressures — already weak — look set to soften further, adding to pressure on the Reserve Bank of Australia (RBA) to cut official interest rates.

That’s the view of economists at the National Australia Bank (NAB) who say both headline and underlying inflation will decelerate further in the March quarter of this year.

“NAB’s forecast for Q1 CPI is for low headline and core inflation outcomes,” said Kaixin Owyong, Economist at the NAB.

After lifting by 0.5% in the December quarter, leaving the annual increase at 1.8%, the NAB expects headline inflation will grow by just 0.2% in the March quarter, seeing the annual rate drop to 1.5%.

For core inflation — of more importance when it comes to the outlook for monetary policy settings — the NAB is looking for a quarterly increase of 0.35%, enough to push the annual rate down from 1.75% to just 1.6% without revisions to prior data.

The core reading is the average of the weighted median and trimmed mean inflation measures released by the ABS.

Such a result would see the core inflation rate move further away from the RBA’s 2-3% medium term target, something the bank has not been able to achieve at any point over the past three years.

With core inflation expected to undershoot again, Owyong says that will likely force the RBA to downgrade its inflation forecasts in May, adding to pressure for the bank to ease policy settings to prevent disinflationary forces from taking hold.

“This will force the bank to further push out its expectation for a return to 2%, from Q4 2019 to Q2 2020,” Owyong said.

“This delay will coincide with a downgrade to GDP forecasts in the May Statement on Monetary Policy, which supports the NAB view of likely interest rate cuts by the RBA in coming months.”

The NAB expects expects the RBA will cut Australia’s cash rate twice this year, starting in July with but with the risk of an earlier move.

ANZ Bank

Like the NAB, economists at ANZ Bank are also looking for a weak Q1 inflation report, forecasting annual increases for headline and core inflation of just 1.4% and 1.7% respectively.

However, unlike financial markets and a growing list of economic forecasters, ANZ doesn’t see the RBA cutting rates again, even with the prospect of another soft inflation report.

In order for the RBA to cut rates in the near-term, it says a super-weak core inflation result will be required in the March quarter report.

“If core inflation for the quarter comes in at 0.3% or lower, it is likely that the near-term inflation outlook will need to be revised lower,” said Hayden Dimes and David Plank, Economists at ANZ.

“A lower starting point will challenge the return to 2% over the medium-term and thus make a rate cut in May a real possibility.”

Citibank’s Australian economics team say the core inflation reading may not even have to be as low as ANZ expects in order to prompt a reaction from the RBA.

“The RBA is forecasting the trimmed mean CPI to rise 1.8% in the 12 months to the middle of this year. This requires average quarterly rises of 0.5% in Q1 and Q2,” it said in a note.

“Anything less than 0.4% in Q1 would require an implausibly high reading in Q2, likely forcing the RBA to downgrade its inflation outlook and test its patience about the timing of a return to target, particularly given this would be coupled with a likely lowering of the RBA’s growth forecast.

“If this scenario is realised then we believe the RBA could cut the cash rate at the May Board meeting.”

In early February, RBA Governor Philip Lowe abandoned the mild policy tightening bias the bank had held for close to a year, suggesting the risks for the next movement in Australia’s cash rate were “more evenly balanced”.

He also nominated two triggers that could warrant additional policy easing — a sustained lift in Australia’s unemployment rate or lack of progress in returning core inflation to the midpoint of its target.

While the unemployment rate hasn’t risen at this point, actually falling to an eight-year low in February, another weak inflation reading could be enough to see the RBA abandon its view that firm job market conditions will eventually help to boost wages and economic growth to a sufficient level to help push inflation back to within its target, especially with GDP growth already sluggish.

Australia’s Q1 inflation report will be released on April 24, just after Australia’s March jobs report arrives on April 18.

Whether or not the RBA will cut Australia’s cash rate in the near-term will likely be determined by the details within these reports.

NOW READ: The RBA isn’t convinced it needs to cut rates – but markets still think it will

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