Inflation figures prompt forecasts of pre-election rate cut

Economists are tipping a rate cut as early as May 7 following lower-than-expected inflation data.

The Aussie dollar slumped but the sharemarket rose after the latest inflation figures.

Lower-than-expected inflation data have increased expectations of official interest rate cuts in Australia, perhaps even before the federal election.

Many economists now expect the Reserve Bank of Australia to lower its official cash rate to a fresh record low of 1.25 per cent at its next board meeting on May 7, even with the federal election looming on May 18.

It follows today’s release of inflation figures showing consumer prices were flat in the first three months of the year - the softest outcome since early 2016.

The figures have sharply increased pressure on the RBA to cut interest rates in the coming months.

Economists at AMP Capital, ANZ, Citi, RBC Capital Markets, JP Morgan and UBS now expect the RBA to cut the official cash rate by 25 basis points in May, and follow that with another cut in June or July, pushing the cash rate down to 1 per cent.

Also today, CBA economists took the opportunity to erase their previous forecast of an official interest rate hike in 2020, but still expect the RBA to avoid a further easing of monetary policy.

Earlier today, the Australian dollar fell but the sharemarket surged when the consumer-price index was unchanged in the first quarter and was up 1.3 per cent from a year earlier.

Economists had expected the CPI to rise 0.2 per cent on-quarter and 1.5 per cent from a year earlier.

Core inflation rose by 0.2 per cent in the quarter, compared with the 0.4 per cent rise expected by economists. It rose by 1.4 per cent on year, well short of economist expectations.

Indeed.com economist Callam Pickering said the data pointed to deep underlying issues across the Australian economy, and created a compelling argument for the RBA to cut the cash rate to a new record low in May.

Sarah Hunter from BIS Oxford Economics said the data suggested that core inflation will undershoot the RBA’s projection of 1.75 per cent year-on-year in the June quarter, increasing pressure to cut the cash rate in the second half.

“For now at least, the disconnect between employment growth and wage increases is continuing,” Ms Hunter said.

The big detractors to the CPI in the first quarter were automotive fuels, which fell by 8.7 per cent compared to the previous quarter. Domestic and international holiday prices also fell sharply, with clothing and footwear also much weaker.

Inflation remains well short of the RBA’s target of 2 per cent-3 per cent on year, which will frustrate policymakers. The Aussie dollar dropped sharply following the consumer-price data release, from about US70.92c to about US70.40c.

Central bankers discussed the merits of cutting interest rates at its April 2 policy meeting, after shifting its policy stance in February from cautiously hawkish to neutral.

The steady drift in the direction of interest rate cuts has come as the economy slowed sharply in the second half of 2018, and as inflation has remained stubbornly low despite official interest rates held at a record low 1.5 per cent since mid-2016.

Global growth has also slowed prompting many of the RBA global counterparts to adopt a more cautious outlook and halt interest rate increases.

The soft inflation outcome points to the RBA downgrading its forecasts for inflation through 2019 in a May review of the economy. It is also expected to downgrade its GDP growth forecasts at the same time.

Financial markets have priced in a strong likelihood that interest rates will be cut twice before the end of the year.

Still, RBA Governor Philip Lowe has indicated that while firms continue to hire and the unemployment rate remains low, or headed lower, the impetus to cut interest rates will be weak.

With Dow Jones Newswires, AAP