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Economists are split over when the next interest rate cut might come from the Reserve Bank of Australia.
Economists are split over when the next interest rate cut might come from the Reserve Bank of Australia. Photograph: Joel Carrett/AAP
Economists are split over when the next interest rate cut might come from the Reserve Bank of Australia. Photograph: Joel Carrett/AAP

Australian inflation goes down and prospect of interest rate cut remains

This article is more than 7 years old

Underlying inflation has dropped from 0.5% in June to 0.4% in September, and some economists suspect that means another interest rate cut is on the cards

Underlying inflation has slipped again, from 0.5% in June to 0.4% in September, keeping alive the prospect of another interest rate cut. But economists are split over when that may be.

Bureau of Statistics figures released on Wednesday show underlying inflation is growing at an annual rate of 1.7%. The Reserve Bank’s target is 2-3%.

“It gives the RBA an excuse to cut interest rates to 1.25% next Tuesday and we wouldn’t rule this out”, said a Capital Economics briefing note to clients.

“We continue to expect the Reserve Bank to cut the cash rate to 1.25% at the November board meeting, although we hold this view without great conviction,” Commonwealth Bank’s chief economist, Michael Blythe, wrote in a note.

The RBA governor, Philip Lowe, dedicated a speech last week to reasons why inflation was so low globally.

He said low inflation and wages in Australia had seen a drop in inflation expectations among consumers and businesses, although not to unprecedented levels.

The RBA board meets on Tuesday, Melbourne Cup day, to decide on interest rates.

“Looking to the future, we expect that the various factors holding inflation down will continue for a while yet,” Lowe cautioned last week.

“But this does not mean that we have drifted into a world of permanently lower inflation in Australia.

“The experience elsewhere suggests that we do need to guard against inflation expectations falling too far, for if this were to occur it would be more difficult to achieve the inflation target.”

Blythe argued on Wednesday that inflation may have bottomed in Australia, for four reasons.

He said the slowdown in inflation rates for services and non-tradeable goods appeared to have ended, while the proportion of consumer price index (CPI) categories that are recording price rises of less than 2% a year had stopped rising.

He also said the categories of goods excluded from CPI were tracking sideways in annual growth terms, while a measure of “structural price” growth had picked up recently.

The RBA would have to juggle conflicting priorities and may decide to tolerate lower inflation, and for longer, for the good of the economy.

“A central bank concerned about low inflation and the risk to inflation expectations may certainly cut,” he wrote.

“But a central bank worried about housing, debt and financial stability may leave interest rates alone.”

The ABS figures for headline inflation complicated the story.

They showed a rise in the annual growth rate of headline inflation from 1% to 1.3% between the March and September quarters.

Headline inflation is different from underlying inflation because its includes prices of goods that can be volatile.

The rise in headline inflation to 1.3% was mainly due to a large 19.5% quarterly increase in the price of fruit and a 5.9% rise in the price of vegetables.

The RBA is likely to look through those numbers because they reflect adverse weather conditions, including floods, in major growing areas, which affected supply.

Other large price increases included electricity (up 5.4%) and tobacco (up 2.3%), which were partially offset by falls in communication (-2.3%) and fuel (-2.9%).

Shane Oliver, AMP Capital’s chief economist, said both headline and underlying inflation are in line with the RBA’s inflation forecasts, and the rise in headline inflation may reduce the likelihood of inflation expectations deteriorating in the short term.

For that reason, the RBA probably will not cut rates next week.

“The RBA can afford to be patient in waiting for inflation to head back to target and thereby avoid the risk of adding to financial instability (read a further acceleration in Sydney and Melbourne home price gains) with another rate cut for now,” he said.

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