LUCI’S CALL: Cooling inflation won’t trigger early rate cut

September quarter inflation came in slightly below expectations but does not change our view that the RBA won’t start cutting interest rates until February at the earliest.

The latest consumer price index data confirmed that the disinflation trend remains on track and supply-side concerns are easing, with the headline rate falling to 2.8 per cent for the year to end-September (Westpac forecast: 2.9 per cent) – back inside the RBA’s 2-3 per cent target band. 

The trimmed mean measure, which the RBA watches closely, is still above target at 3.5 per cent, although we think the outcome would have been in line with the central bank’s expectations. 

A number of key categories of essentials expenditure came in below our expectations, though some key services components, for example education and holiday travel, were a little higher than we expected, too.

Revisions to output, hours worked, and productivity data in the annual national accounts should further reduce potential concerns about ongoing inflation in the domestic cost base. 

All of this suggests that risks of a further rate hike have faded, but neither do recent data imply that rate cuts need to be brought forward from our current expectations. Given the uncertainties surrounding the U.S. election and its aftermath, it’s likely that the RBA will hold steady at the November 4-5 Board meeting and see how global events play out. 

Even so, the RBA’s consistent message that it is ‘not ruling anything in or out’ in terms of its policy options will become increasingly hard to justify the longer disinflation remains on track. The November meeting will include revised economic forecasts and they could provide an opportunity for the bank to give a clearer signal that rate cuts are on the horizon. 

There are a few other things to watch out for from the meeting:

- Will there be any shift in the RBA’s assessment of the level of supply, and spare capacity, in the economy following the revisions in the national accounts data?

- How will the RBA integrate views about energy prices into its forecasts for inflation in 2025 and beyond? Headline inflation was dampened by the government’s electricity bill rebates in the September quarter, but the RBA is focusing instead on the underlying measures. Will that still be the case when the rebate effect drops out in late 2025 and underlying inflation falls below the headline rate?

- How will the RBA’s assessment of upside risks from household spending and the housing market shift? The spending response to the Stage 3 tax cuts is still looking quite modest. Meanwhile, housing prices in Sydney are starting to turn, joining Melbourne as a market that is no longer increasing significantly. Future rate cuts could turn this around, but it no longer seems that wealth effects pose a material upside risk to spending.

Fresh insight from the RBA on these questions will be welcome, but ultimately the bar is still too high for the RBA to start the easing cycle this year. 

The labour market remains resilient, even if employment growth has to run hard just to keep pace with strong population growth and the trend rise in workforce participation. And while the spending response to the tax cuts looks to be less than expected, it is not zero. 

So, barring a major external shock, we do not see the economy hitting a wall in the next few months, enough to shift the RBA’s thinking on the timing of rate cuts. 

If things turn out weaker over the next couple of quarters, a faster trajectory for the rate-cutting phase could occur. But a start date earlier than February seems like a low-probability outcome. 

To read Luci’s note in full, visit WestpacIQ.