Why inflation will be no barrier if the RBA wants or needs to cut rates in Australia

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Does Australian inflation give the RBA the opportunity to ease rates again? That’s the questions economists and traders will be asking in the wake of the Greek ‘No’ vote and the release of the TD Securities monthly inflation gauge, which rose just 0.1% in June.

No-one expects the RBA to do anything other than retain its cautious tone after tomorrow’s board meeting. But in the same way as some analysts are already pushing back forecasts for the first US Fed tightening, the benign inflation outlook gives the RBA plenty of room to cut if they want to, and the need arises.

The key is the 0.1% rise in the TD gauge, which takes the annual rate of inflation to June to just 1.5%. The trimmed mean, which takes out volatile items like petrol, also rose 0.1%, up just 1.4% over the previous 12 months.

As a result TD is forecasting the official ABS Q2 CPI to rise 0.7%, taking the annual rate to just 1.6%, well below the RBA’s 2-3% target band. The underlying rate is expected to rise just 0.4% for an annual rate of 2.2%.

One thing worth noting is that Prashant Newnaha, rates strategist at TD Securities said a breakdown of the TD inflation gauge reveals “a steady trend pick up in the number of expenditure classes posting increases in prices in the past three months while the number of expenditure classes registering falls in price over the same period has decreased.”

That’s interesting economy watchers like me who believe activity drives prices. It could be a sign of where Australia’s economy is headed.

Newnaha added “it is too early to state that upside price pressures are brewing, but the data supports fixed income price action that the worst of the deflation scare is over”.

That said, and even though Newnaha believes tomorrow’s RBA meeting will pass without much fanfare, he adds “as we expect weak data reports in the weeks and months ahead, the next move is more likely to be down than up, a factor that will be supportive of the RBA’s call for a lower AUD.”

Australians should hope the economy doesn’t get in the position to need another rate cut. But at least the inflation outlook won’t be an impediment if markets get into a funk.

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