Surprise drop in inflation puts the spotlight back on possible rate cut

Posted on April 27, 2016 by Pete Faulkner - Inflation, Uncategorized

Today’s release of first quarter CPI has shocked the market with a reading much weaker than had been expected. Headline CPI fell by 0.2% q/q (against expectations of a 0.2-0.3% rise) for an annual rate of just 1.3% (expected around 1.7%).

The more closely watched Trimmed Mean (+0.2% q/q, +1.7% yr/yr) and Weighted Median (+0.1% q/q and +1.4% yr/yr) were also much weaker than had been expected and take average core inflation to +1.55% yr/yr. This is well below the RBA’s target range of 2-3% and the first time since Q2 2012 that the range had been breached (when average core inflation briefly dipped as low as 1.85%). This is the lowest average core inflation print for at least 17 years.

Areas where prices fell sharply in the last quarter were clothing (-2.6% q/q) and transport (-2.5% q/q). Over the course of the year these sectors have fallen 0.8% and 0.5% respectively while communications is down 6.4% for the year (its 8th consecutive quarter of yr/yr falls).

Inflation falling to such low levels will inevitably return focus to the possibility of further rate cuts from the RBA. Since the release of the CPI data the market has moved pricing for a 25 bps cut at next weeks May RBA meeting from about 12% to almost 50%. Likewise, the currency market has responded sharply taking the A$ down from US$0.775 to about US$ 0.765 in the 30 minutes after the release.

While the inflation print is certainly very low other indicators such as employment and GDP are painting a firmer picture and we would therefore be surprised to see the RBA cut on Tuesday. However, given the reality that the Bank needs to wait another 3 months for its next inflation data, there is certainly a possibility that they may wish to strike early. The recent strength in the A$ would also help them to reach for the rate cut trigger. Today’s A$ weakness, while perhaps easing some of the pressure on the Bank to act on rates, is likely to be reversed if no cut is forthcoming next week.