The RBA might cut rates today but this fund manager says inflation is coming back in Australia

Photo by Uriel Sinai/Getty Images

It’s clear that Australia hasn’t escaped the global deflationary spiral. The first quarter’s headline print of -0.2% might look aberrant now that the a more normal second quarter headline print of 0.4% has been released.

But the fact that the year on year rate fell to 1%, the lowest level since 1999, shows that Australia certainly has a low inflation problem.

That is something the market expects the Reserve Bank to address with a rate cut of 0.25% after this morning’s board meeting. If expectations are fulfilled, that will take the RBA cash rate to a new all-time low of 1.5%.

Some forecasters, like Capital Economics, believe low inflation will drive rates to 1%.

But Chris Rands, fixed income portfolio manager at Nikko Asset Management in Sydney, says commodity price rises in recent months “indicate a rebound in Australian inflation” is coming.

In a blog on the Nikko website, Rands says the reason the much anticipated uptick in inflation as a result of the fall in the Aussie dollar hasn’t occurred is because “the real driver of inflation in Australia has been lower commodity prices as the economy transitions away from the mining boom”.

As result he says, “if the recent stabilisation in commodity prices can continue, then this would suggest the low point for inflation could be closer than expected”.

This is an incredibly out-of-consensus view with many forecasters focused on a continuation of recent trends.

That’s something Rands recognises when he says “inflation will likely remain low for some time”.

Rather “this recent stabilisation in commodities means that the risk of inflation falling below 1% is reduced. In our view, it is now more likely that it will rebound higher, albeit moderately, over the next six months,” he said.

Rands suggests the recently broken relationship between commodity prices and inflation will reassert itself with “inflation returning closer to 2% over the next six months, rather than continuing its fall to under 1%”.

Part of the transmission mechanism for this, Rands says, is that improved commodity prices will feed into the terms of trade, which in turn will feed into gross national income and then ultimately into wages growth.

Rands said:

The slower wage picture is commodity price-related because gross national income remains weak, following the terms of trade. However, the recent stabilisation of commodity prices again points to gross national income beginning to improve, which should reduce the pressure for lower wages and help to arrest the decline in domestic inflation.

If Rands and his colleagues at Nikko are correct then the Reserve Bank doesn’t need to cut rates today.

But given Rands believes inflation is still going to stay low for some time, the risks of a policy mistake from the RBA seem low.

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