February interest rate cut near certain as inflation undershoots

Financial markets are near certain that the Reserve Bank will cut rates in February after CPI data showed underlying inflation is falling back to its target more rapidly than forecast.

RBA governor, Michele Bullock. Picture: NewsWire / Jeremy Piper

Financial markets are near certain that the Reserve Bank will cut interest rates in February, after the latest CPI data showed underlying inflation is falling back to its target more rapidly than forecast.

Market pricing on the chance of an initial quarter per cent cut in the official cash rate target from its current level of 4.35 per cent soared to 96 per cent after the RBA’s preferred “trimmed mean” measure of inflation hit a four-year low of 3.2 per cent, well below its forecast of 3.4 per cent.

Follow-up interest rate cuts were more than fully priced for May and August.

Traders also saw some chance of a fourth cut in the cash rate to 3.35 per cent by December.

Growing expectations that interest rate cuts were imminent weighed on the Australian dollar and magnified a rise in stocks, while domestic bond yields hit multi-week lows.

The Australian dollar hit a one-week low of US62.27c, down as much as 1.4 per cent this week after renewed jitters about US trade policy and Wednesday’s lower than expected inflation data.

The S&P/ASX 200 stock index was on the cusp of record highs after rising as high as 1 per cent.

In the bond market, the 10-year Australian Commonwealth Government yield hit a six-week low of 4.36 per cent, while the interest rate sensitive 3-year yield hit a two-month low of 3.78 per cent.

The CPI data also caused a scramble by economists to predict earlier rate cuts.

Three of the four major banks were predicting cuts in February after Westpac brought forward its forecast from May. NAB said February “remains live” while putting its forecast under review.

Forecasters including Bank of Queensland, Capital Economics, Citi, RBC Capital Markets and TD Securities and UBS also rushed to bring forward their prediction on the start of rate cuts to February.

Goldman Sachs Australia chief economist Andrew Boak predicted back-to-back rate cuts in February and April after front-loading his interest rate forecast profile in response to the CPI data.

“While year-ended growth in the trimmed-mean measure is still a bit above the RBA’s 2-3 per cent inflation target, sequential momentum in quarterly annualised growth decelerated materially over 2024 and is now tracking at the lower end of the RBA’s target band,” he said.

The data backed his view that inflationary pressures have eased materially in Australia, with key core measures likely to stabilise around the midpoint of the RBA’s 2-3 per cent target band in 2025.

Westpac chief economist, Luci Ellis, a former RBA chief economist, said its view of the economy will “need to pivot further” away from its view that demand is still outstripping supply.

“With trimmed mean inflation at 0.5 per cent in the quarter, we have just enough evidence to conclude that disinflation has proceeded faster than the RBA expected, so the board will have the required confidence to start the rate-cutting phase in February,” Ms Ellis said.

“In addition to the trimmed mean outcome, we see encouraging signs in housing-related inflation suggesting that the momentum in domestic price pressures is fading a bit faster than the RBA feared.

“Both rents and home-building costs have decelerated noticeably in recent months, and not just because of government cost-of-living support.”

She said the labour market has been stronger than expected and recent wages data would not have induced enough of a downward revision to its assessment of the unemployment rate consistent with full employment to bridge the gap.

In late December, the RBA said the implied NAIRU (non-accelerating inflation rate of unemployment) assumption of its models was 4.52 per cent, above the December unemployment rate of 4 per cent.

But “the good news on inflation beats the stronger news on the labour market”, Ms Ellis said.

In her view, the forthcoming change of the make-up of the RBA board “could create some awkward optics around timing” if the RBA were to delay a rate cut until April.

“If the current board held rates steady in February and then the revamped board cut rates in April, it would look like the government ‘stacked’ the board to get the desired result,” she said

“So there is an argument that the current board will opt to get on with it rather than get caught up in the politics of the situation.”

Similarly, UBS chief economist George Tharenou said that while key economic indicators have been stronger than expected since the February board meeting “CPI trumps everything” as trimmed mean inflation was “materially below” the RBA’s forecast for the December quarter.

The average rise in the trimmed mean CPI over Q3 and Q4 was just above 2.5 per cent annualised, meaning “inflation momentum” was already near the middle of the 2-3 target.

CBA head of Australian Economics, Gareth Aird, said the fall in underlying inflation gives the RBA a “green light” to start “normalising” the cash rate after its February meeting.

“Restrictive monetary policy has done its job in pulling underlying inflation back toward the RBA’s target band. Economic growth is well below trend and wages growth has slowed more materially than the RBA forecast. The RBA’s preferred measure of underlying inflation is now not far from the mid point of the target band on a six month annualised basis.”

Betashares chief economist David Bassanese saw a good chance trimmed mean inflation falling the RBA’s 2-3 per cent target band by June, rather than its recent forecast of December 2025.

“As a result – and despite still solid employment growth – there’s no question the economy deserves an interest rate cut to ease the restrictiveness of current policy settings,” he said.

“My expectation is the RBA will follow up with two further rate cuts this year, not immediately but likely following confirmation of further declines in inflation in the next few quarterly CPI reports.”

Originally published as February interest rate cut near certain as inflation undershoots