Australia inflation drops to 4.9%, strengthens argument to extend pause

In July, inflation in Australia dropped to its lowest point of 4.9% in 17 months, mainly due to reduced holiday travel and fuel costs. Even the core inflation measure, which looks at essential price changes, showed a decrease, which suggests that there might not be a need to increase interest rates.

Consequently, the markets adjusted their expectations and now believe with a 99.5% likelihood that the Reserve Bank of Australia (RBA) will not increase interest rates for the third consecutive month in September. Furthermore, the final rate hike probability dropped to just 35%, indicating that the RBA is mostly finished with its tightening measures.

Australia’s inflation is slowing down 

On Wednesday, data released by the Australian Bureau of Statistics revealed that the country’s monthly consumer price index (CPI) increased by 4.9% in the year leading up to July. That marked a decline from the 5.4% seen in the previous month and fell short of market predictions of 5.2%.

Meanwhile, there was a positive development as the CPI rose by 0.3% in July every month. That brought the three-month annualized rate to 2.8%, which falls within the Reserve Bank of Australia’s target range of 2-3%. Notably, the price increase for tradable goods eased to 1.7% in July compared to last year, a significant decrease from the nearly 10% rise recorded towards the end of the prior year, which suggests that global disinflationary trends are impacting Australia.

As a result, the Australian dollar experienced a drop to $0.6450, and three-year bond futures experienced an 8-tick rally, reaching 96.26. AMP’s chief economist, Shane Oliver, commented on the situation, stating that the inflation numbers were lower than anticipated, partly due to energy subsidies. He observed that the annual inflation rate is decreasing across all categories of prices except for rent, which saw a 6% increase in July compared to June. 

Michelle Marquardt, head of prices statistics at the ABS, mentioned that electricity prices could have surged by 19.2% in a single month without government rebates. Additionally, rent inflation accelerated to 7.6% in July from 7.3%, indicating the potential for persistent services inflation.

RBA to hold off on increased interest rate hikes

Having increased rates by a substantial 400 basis points to reach an 11-year high of 4.1% since May of the previous year, the RBA now faces a more nuanced decision. 

The central bank chose to put a temporary hold on its actions to evaluate the effects of its campaign to increase rates this month. The decision came in light of a complex economic situation: consumer spending has moderated due to a growing need to allocate a larger portion of their earnings to repayments, whereas business confidence remains relatively steady. However, incoming Governor Michele Bullock cautioned that rates might need to be raised again, emphasizing policymakers’ careful monitoring of data.

Current data trends have generally supported the idea of a prolonged pause in rate increases. Although retail sales exhibited some resilience in July, the overall performance was modest, wage growth was underwhelming, and there were indications of a potential shift in the previously robust labor market. A key measure of core inflation, the trimmed mean, eased from 6.0% to 5.6%, while prices excluding volatile items like fruits, vegetables, fuel, and holiday travel increased by 5.8% in the year leading to July, down from 6.1% in June.

David Bassanese, an economist affiliated with BetaShares, pointed out that the inflation data for July has solidified the argument for the RBA to maintain the current interest rates during its upcoming policy meeting. He forecasted that the central bank’s next move would involve a reduction in interest rates around April of the following year, followed by two more rate cuts by the close of 2024.

Bassanese emphasized that as long as overall inflation continues to decrease, Australia might not have to endure an extended period of below-average economic growth or even face a ‘per capita recession.’ He elaborated that the unemployment rate necessary for inflation to align with the desired target might be considerably lower than the RBA’s current assumption of a peak rate of 4.5%.

Shane Oliver from AMP summarized the situation, noting that efforts to reduce inflation are progressing. However, uncertainty remains about the risk of entering a recession, a concern still lingers.

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