Reserve Bank to hold the line despite inflation drop

Headline inflation plunged to its lowest level in three-and-a-half years in the 12 months to September, but the decline is unlikely to convince the Reserve Bank to begin cutting rates as it remains concerned over stubbornly persistent price pressures.

A record reduction in electricity prices as households received $75 energy bill rebates drove inflation to a three-and-a-half year low in the 12-months to September, but the decline is unlikely to convince the Reserve Bank to begin cutting interest rates.

Annual headline inflation rose 2.8 per cent from a year earlier, the Australian Bureau of Statistics said on Wednesday, down from 3.8 per cent in June. That was a touch softer than the 2.9 per cent that economists predicted, and the lowest reading since March 2021.

However, the RBA’s preferred underlying inflation gauge – trimmed mean inflation, which strips out more volatile price changes – climbed 3.5 per cent over the previous 12 months, down from 4 per cent in June. That figure was in-line with economists’ expectations and still remained well outside the central bank’s 2 to 3 per cent target band.

Despite the decline, most economists do not expect the RBA to begin cutting interest rates until its first two-day board meeting for 2025, scheduled for February 17-18, as inflationary pressures remain sticky, particularly in the labour-intensive services sector.

Indeed, services inflation re-accelerated to 4.6 per cent in the year to September, up from 4.5 per cent in June.

Driving the uptick was a sharp increase in insurance prices, which rose 14 per cent, reflecting higher reinsurance, natural disaster and claim costs.

Education costs also rose strongly, up 6.4 per cent over the same period, with childcare the main driver, jumping 12.1 per cent, as increased operating expenses pushed fees higher.

Additionally, rental costs climbed 6.7 per cent as vacancy rates remained near historic lows and the rental market remained tight.

But even as prices continued to rise for most goods and services, the introduction of federal Labor’s $300 power bill rebate helped drive the sharp decline in the headline inflation rate. The Commonwealth support was topped up with an additional $1000 lump sum payment in Queensland and an extra $400 rebate in Western Australia.

The measures caused electricity prices to dive 17.3 per cent in the September quarter. Without the rebates, electricity prices would have increased 0.7 per cent, the ABS said.

However, given the temporary nature of the subsidies, which are set to expire by mid-2025, RBA governor Michele Bullock has repeatedly stressed that the central bank will ignore the reduction in headline inflation and instead focus on more persistent underlying price measures.

According to its staff forecasts, the RBA expects inflation to rebound to 3.7 per cent by the end of next year, and will not sustainably return to its target until the second half of 2026.

Also helping to reduce the headline CPI reading was relief for motorists at the bowser with fuel prices down 6.7 per cent. Average retail petrol prices retreated to $1.84 a litre during the September quarter, down 13 cents on the June quarter, amid deteriorating Chinese demand and robust global supply.

Together, the power bill rebates and the fall in the fuel price subtracted a hefty 0.6 percentage points from the annual headline inflation result.

Alongside economists, investors are similarly sceptical about the prospect of near-term rate cuts. Money markets are fully priced for a quarter percentage point cut at the RBA’s May meeting – just four days before the cut-off for the pending federal election – which would take the cash rate to 4.1 per cent.

Wednesday’s inflation report will be a key point of discussion when the RBA board meets again next week. Ahead of the fresh figures, investors tipped just an 8 per cent chance of a rate cut then.