Improved inflation figures to swing RBA rate decision back to the Albanese Government’s favour

The consensus for a rate cut continues to swing the government’s way.

With Wednesday’s official inflation data showing a fall in the underlying rate to 3.2 per cent from 3.6 per cent in the September quarter, the Reserve Bank of Australia will have a lot more confidence that it can safely cut interest rates at the February meeting.

Headline inflation, helped by government rebates for electricity and rent assistance has fallen to 2.4 per cent, well within the bank’s target range of between two and three per cent.

Markets are increasingly bullish, pushing the likelihood that rates will be cut at the next meeting to 84 per cent. Last month, the probability of a rate cut was 70 per cent.

The country’s top economists are also starting to crack. Before Wednesday’s numbers, two of the big four banks forecast a rate cut in February and two a cut in May.

Westpac, led by former RBA deputy governor Luci Ellis, has just revised its call.

Amid all of the noise that recent economic data has been throwing up, the CPI figure has been the “deciding factor”.

“With trimmed mean inflation at 0.5 per cent in the quarter, we have just enough evidence to conclude that disinflation has proceeded faster than the RBA expected, so the Board will have the required confidence to start the rate cutting phase in February,” Ms Ellis said.

NAB continues to stick by its forecast of a May cut but chief economist Alan Oster told The Nightly the bank is now “reconsidering their forecasts”.

Saved by houses

A major factor in Westpac’s reassessment was the significantly better than expected housing data, which showed inflation dropping 0.7 per cent over the quarter.

The ABS said that the cost of a new dwelling for owner-occupiers fell for the first time in 3 ½ years, thanks to increasing incentives and promotional offers from project home builders offsetting slightly higher labour costs.

Rents also moderated over the quarter, falling in Hobart and Canberra, and while rent’s inflation remains elevated at 6.4 per cent annually, it is growing at the weakest rate in almost two years. While the government has been helping renters with rebates, the underlying picture is looking much better.

“Because (housing) has implications for the future, there’s been a lot of discussion around different policies and how they’re affecting prices temporarily,” Ms Ellis said.

“In both rents and home building, the underlying trend has come off a bit more than we expected, and that says to us that the underlying inflation from that sector is likely to be lower in the next couple of quarters as well.

“It’s not just a flash in the pan.”

Government rebates are also helping consumers in the face of continuing stubborn energy costs.

Power prices continue to be 15 per cent higher than June 2023, and while they have come down from the peak, energy costs have flatlined for the last three quarters.

The long-term, structural energy issue is being masked by Commonwealth and State rebates, which have helped push power prices down 25 per cent in the past 12 months. But Ms Ellis said that overall effect is relatively minimal, Ms Ellis said, as they were excluded, or trimmed, from calculations on underlying inflation.

“Our assessment is that the effect on trimmed mean is actually very small,” Ms Ellis said.

Mortgage relief ahead

Cuts sooner than later will be welcome news for homeowners, who have had to watch interest rates remain at 4.35 per cent since November 2023.

Most forecasts are for a 0.25 per cent cut in February with investment bank RBC suggesting there will also be similar sized cuts in May and August. That would bring the official cash rate down to 3.6 per cent.

Deloitte Access Economics, in their quarterly business outlook, suggest that rates will fall a further three quarters of a per cent in 2026. By the end of 2026, Deloitte said, the average mortgage-holder would be $8,000 better off in today’s dollars.

Rate cut kickstart

A rate cut would also be welcome for the business community. With growth stuck at less than one per cent, and falling 1.5 per cent on a per capita basis, the economy has been stagnating.

That was confirmed by NAB yesterday, which found business confidence continues to be negative – a position it has been in for two years. Business conditions remain also remain low, hovering at our below-2024 levels.

Business confidence has not been helped by a spending drought by consumers. Westpac estimates that consumer jitters has kept wallets closed, meaning that just 25 per cent of the recent tax cuts have been spent, with the remainder going into rebuilding drawn down savings.

Deloitte is hopeful that rate will change that.

“The effect of lower interest rates on household incomes is anticipated to be a major driver of the forecast recovery in the Australian economy in 2025,” Deloitte economists said.

Ms Ellis is also hopeful that a rate cut will unleash animal spirits in the business community.

While she doesn’t expect that a 0.25 per cent rate cut will be materially different in terms of encouraging greater investment, she said there’ll be a “certain level of relief that finally they’ve started. That will just remove a sense of uncertainty.”

Global deflation flowing through

The stubborn inflation caused by the pandemic and Russia’s invasion of Ukraine is starting to finally ease.

Repaired supply chains have already flowed through to goods inflation, which showed its lowest level since 2016. Falling fuel costs, due to lower global oil demand was a significant driver, but over the quarter there were significant declines in prices for imported products like clothes, shoes and household appliances. Many of those declines were helped by Black Friday discounting, but even stripping out discounts, are running well below the RBA’s inflation target.

The ABS data also demonstrated the lagging impact of goods inflation on services inflation, which has stayed stubbornly higher for longer.

Insurance, for example, continues to experience price rises of 11 per cent, but has fallen from the 16 per cent annual growth of two years ago.

Cheaper imports, and higher supply has meant the cost of repairing a house or car is falling, Ms Ellis said, meaning insurers need not apply as a high a premium to cover costs.

Also helping the economy will be the roll-off of workers from huge publicly funded infrastructure projects. More worker availability should help bring down costs for labour-intensive areas like housing.

The labour market will be the last piece of the puzzle in the RBA’s deliberations, and barring unexpected strength, Treasurer Jim Chalmers will be doing a victory lap.

The RBA can take a bow too.

Together they will have navigated a soft landing without kneecapping the jobs market.

A chart prepared by AMP shows that Australia’s inflation experience is on a par with the experience of the US, UK, Canada and the EU without the same level of interest rate pain.

Longer term, there is much work to be done to get living standards back to where they were before the pandemic. But for now, the economy is headed in the right direction.