January CPI data is welcome news for the RBA as watchers pencil in a rate cut for September

Australia’s lower-than-expected CPI for January will be reassuring to the RBA as it seeks evidence that inflation is heading for its target range.

Inflation is probably still too high for the RBA board to drop its tightening bias when its board next meets.

Australia’s lower-than-expected CPI indicator for January will be somewhat reassuring for the Reserve Bank as it looks for evidence that inflation is moving sustainably towards its target range.

A dovish shift in financial markets to imply the RBA will start cutting rates in September also came as the Reserve Bank of New Zealand decided not to lift rates at its monthly board meeting.

While the market only saw a 20 per cent chance of the RBNZ lifting rates, there was some nervousness after ANZ Bank predicted a restart of rate hikes in New Zealand because of stubbornly high inflation.

The Australian dollar jumped 0.6 per cent to an eight-day high of $NZ1.068 after the RBNZ’s decision after hitting a nine-month low of NZ$1.0560 this week.

Betashares chief economist David Bassanese.

While trimming the projected peak in its interest rate track this year from 5.7 per cent to 5.6 per cent, the RBNZ said it “needs to remain at a restrictive level for a sustained period of time”.

But while implying a 36 per cent chance of another rate hike by the RBNZ by May, overnight index swaps implied 50 basis points of cuts by the RBNZ by year end.

The Australian rates market implied a steadily-increasing chance of rate cuts by the RBA. A 25 basis points cut was implied by September and 41 basis points of cuts were implied by the year end.

Inflation is probably still too high for the RBA board to drop its tightening bias when it meets next month. The CPI indicator remained at 3.4 per cent or almost 1 percentage point above the midpoint of the RBA’s 2-3 per cent target band. However it undershot a 3.6 per cent rise expected by economists and remained well below the Covid-19 era peak of 8.4 per cent.

The RBA is unlikely to shift its quarterly inflation forecasts at this point due to the incompleteness of the January CPI indicator, but there’s no doubt inflation is heading in the right direction.

Importantly, disinflation looks to be occurring at a pace consistent with the RBA’s forecasts for inflation to return to the midpoint of its target band by mid-2026, forecasts which are based on assumptions that include the cash rate staying around the current level of 4.35 per cent until the middle of 2024, before falling to around 3.25 per cent by the middle of 2026.

“All up, the CPI release should be broadly reassuring to the RBA and, on balance, reduces the risk it might consider another rate increase in coming months,” Betashares chief economist David Bassanese said.

Goldman Sachs Australia chief economist Andrew Boak.

“Indeed, the CPI result remains consistent with my view that the RBA will have capacity to cut rates at least twice in the final months of 2024.”

Goldman Sachs Australia chief economist Andrew Boak said it was encouraging news.

“From the RBA’s perspective, the ongoing easing in sequential inflation pressures is likely to be seen as encouraging, with three-month annualised core inflation now tracking below 3 per cent for the first time since 2021,” he said.

“That said, we are mindful that a range of services items were imputed to be zero per cent month-on-month in January given they are not measured in the first month of the quarter.”

Updates on price changes for many of these services items will come in February’s data.

The monthly CPI indicator should be viewed favourably by the RBA board at its March 18-19 meeting, especially in the global context of a rising trend in inflation in January.

However, the RBA will stay cautious, says AMP deputy chief economist Diana Mousina.

“Given the monthly CPI is not yet a complete measure of inflation, because it doesn’t measure all price categories every month, and in January many services aren’t measured, the RBA would probably be cautious in its interpretation of the monthly data,” she said. “Headline inflation is still higher than the RBA would like and the core measures of inflation have not fallen as much as the headline numbers.”

AMP deputy chief economist Diana Mousina.

The monthly trimmed mean is at 3.8 per cent over the year and the CPI ex volatile items and travel is at 4.1 per cent. Both are reasons for the RBA to stand pat on keeping interest rates unchanged.

“While other central banks like the US Fed and ECB have dropped their tightening bias on interest rates, the RBA will probably maintain its mild hiking bias, out of concern that any talk of interest rate cuts would lead to a lift in inflation expectations and a renewed lift in inflation,” she added.

Whereas the first month of the quarter focuses on durable goods, such as clothing and household goods, rather than services and domestically driven factors, the February data are more important for the central bank’s understanding of the inflation pulse.

“The February CPI reading will round out our understanding of first quarter inflation, given it has more of a focus on services, which have shown persistent price pressures,” said EY senior economist Paula Gadsby.

“Talks of rate cuts could be premature as risks persist into 2024, especially if wages growth – the major driver of inflation – fails to ease, and productivity doesn’t pick up to the long-run levels the Reserve Bank is counting on.”

NAB saw few implications from the CPI indicator. “Our view is that the RBA is unlikely to be in a position to cut until late this year,” said NAB senior economist Taylor Nugent. “While wider signs the economy is moving back towards balance are likely to be enough to prevent the RBA pursuing further rate rises, we expect the board to take a cautious approach to easing policy settings.”