Inflation data key to RBA’s rates call

Interest rate swap markets already imply a 70pc chance of an interest rate cut next month.

Australia’s latest inflation data looks set to be the deciding factor that could trigger a central bank rate cut in August.

The inflation numbers, due on Wednesday, are expected to confirm that a return to the Reserve Bank of Australia’s desired inflation target band of 2 per cent to 3 per cent is still years away, giving policy makers a compelling case to use some of the firepower they retain.

Like many of its global counterparts, Australia is experiencing low inflation. Record low wages growth, falling energy and commodity prices, and heated competition in the retail sector go some of the way to explaining local data that showed a quarterly drop in prices in the first three months of 2016.

While economists surveyed by The Wall Street Journal say headline inflation is likely to pick up to 0.4 per cent in the second quarter, and 1.1 per cent on year, that still leaves the central bank short of its projected level for the year. Polled economists said that inflation of 0.4 per cent or less would clear a path to an interest rate cut.

Interest rate swap markets already imply a 70 per cent chance of an interest rate cut next month. Those bets will rise sharply if the inflation numbers prove as benign as many economists expect them to be.

For its part, the RBA has made it clear the inflation data are central to decision making around interest rates at its August 2 policy meeting. The bank last cut rates in May following the worse-than-expected first quarter inflation data.

At that time, the RBA forecast underlying inflation would reach 1.5 per cent for the year to June. With nearly 1.0 per cent already accounted for in the first three quarters, the bank needs a 0.5 per cent print for inflation to fit in with its forecasts.

“The CPI numbers are always important for the RBA. However, this quarter the number is even more critical to the central bank’s next decision than usual,” said Paul Bloxham, chief economist at HSBC, Australia.

“This is because the first-quarter CPI print surprised significantly to the downside and the second quarter print will hopefully help to clarify whether this was the beginning of a trend for much lower inflation or due to one-off factors,” Mr Bloxham said.

Still, risks around cutting interest rates exist, especially in the area of already soaring house prices and the potential for a housing market bust to cause financial sector instability.

- Dow Jones newswires