Inflation data for August showed Australia reached the Reserve Bank of Australia’s target range of 2-3%. (AAP/Yahoo Finance Australia)
There has been a lot of big news over the past few days on the inflation and interest rate front. The surprisingly good news is that inflation is back within the target range and is expected to fall further as a weak economy, rising unemployment, global deflationary pressures and wage suppression all start to kick in.
The August Consumer Price Index showed annual inflation slowed to 2.7% from a peak of 8.4% in December 2022, putting it back within the target range for the first time in several years.
With economic and inflationary momentum so strong, it is very possible, even likely, that inflation will drop to 2% or below in the coming months.
This sharp drop in inflation indicates that the Reserve Bank of Australia’s (RBA) aggressive interest rate hikes between May 2022 and November 2023 are working.
The economy is in ruins, unemployment is rising, and inflation is spiralling down the road towards target.
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The decline in inflation was driven in part by the federal government’s $75 per quarter electricity subsidy to consumers and by a drop in gasoline prices, which have fallen more than 7 percent over the past year.
These disinflationary factors were partially offset by increases in government excise duties, particularly on tobacco and alcohol.
Furthermore, rising costs of education, insurance, and health care are also less affected by rising or falling interest rates.
The RBA’s inflation forecasts are clearly too high.
This is one reason why Japan has been reluctant to cut interest rates at a time when central banks around the world are doing so in light of their weak economies and falling inflation.
What’s shocking in this context is that the Reserve Bank of Australia (RBA) left interest rates unchanged at a very restrictive 4.35% at its meeting this week.
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Governor Michel Blok suggested that interest rate cuts were not on the bank’s agenda, despite slowing economic growth, rising unemployment, global interest rate cuts, slowing wage growth and falling inflation.
Her assessment is that some of the inflation is “sticky” and the labor market remains “tight.”
These decisions are only a small part of the economic picture, but they are influencing the RBA’s forecast for inflation to remain high.
Indeed, while Brooke downplayed the decline in inflation by saying the Governing Council’s focus was on artificial measures such as so-called underlying or trimmed average inflation, there is no mention of these inflation measures in the Statement on the Conduct of RBA Monetary Policy, signed by Brooke and Treasurer Jim Chalmers in December 2023.
In other words, the RBA is refusing to cut rates because it believes the drop in inflation in August will be temporary, and so its decision is based on belief rather than fact.
In the end, markets accepted the low inflation outcome and again downplayed the RBA’s economic outlook, seeing a more than 50% chance of a 25 basis point rate cut by the end of 2024 and a total of 125 basis points by the end of 2025.
From this perspective, and if you take a cold, dispassionate look at the economic data, especially on inflation, this seems about right.
Of course, things can change quickly and markets may reassess their economic outlook.
The next few Labour Force and Consumer Price Index releases, coupled with interest rate decisions around the world, are likely to indicate a clear change of policy from the Reserve Bank of Australia (RBA) sooner rather than later.
Inflation has been conquered. The focus now is on keeping unemployment from rising.