Another disappointing read on inflation in the monthly series, but potentially another market overreaction to this one data point. Our latest thoughts and forecasts, as the new financial year kicks off.
The monthly CPI indicator for May was a setback to progress on inflation with headline CPI jumping to 4 per cent and the core Trimmed Mean also higher at 4.4%, although some of the detail within the report was less conclusive.
There’s no doubt that this does increase the probability of another RBA hike in the coming months, but our key takeaway from the data was that it further defers RBA cuts (which we didn’t expect until next year in any case) rather than necessarily implying another rate hike.
As we’ve outlined here and in our Business Insights website since early 2023, we see relief via RBA rate cuts as a 2025 event, so we’re not surprised that markets (and most economists) are no longer pricing in cuts this year, but the market is now assigning around a 50% probability to another hike, which is a long bow to draw after just one monthly CPI read. Nevertheless, we have pushed back our first RBA cut from next February to May ’25, given the even slower progress for disinflation than hoped.
Another source of uncertainty ahead is fiscal policy, now that the Stage 3 tax cuts are underway (worth around $22 Bn this Financial Year), on top of a range of ‘cost-of-living measures’ in Federal, State and Territory budgets worth close to $30 Bn.
How much of this money is spent versus saved will be crucial for imbalances between supply and demand, which importantly will take time to become apparent, and there are a range of other arguments against further RBA hikes:
• The latest inflation numbers were just one in a series, and not from the full quarterly report (to be released at the end of this month)
• As we are seeing overseas, while these numbers do jump around, they have generally been falling, hence the recent rate cuts in Europe and Canada; and
• The RBA will look at a broad range of data maintaining their focus on the dual mandate of price stability while aiming for full employment.
This means upcoming jobs data will be almost as influential as inflation data, so the next labour force report out on July 18th will be important for policy settings. Our expectation (as job vacancy and job advertisements are starting to weaken in line with the slowing economy) is the unemployment rate moving gradually higher, but the RBA remain data dependent, so any surprises with this or from the quarterly CPI data later in July will be closely scrutinised.
Beyond speculation on interest rates, economic conditions remain uneven and in some respects contradictory: Record highs for property prices, stock markets and levels of employment, but we remain in a per-capita recession and consumer sentiment is lower than it was in the pandemic or the GFC, so with household budgets stretched, the tax cuts are arriving at the right time.
Our forecasts for the new financial year still show moderating inflation, helped by base effects and a firm Aussie Dollar and more moderate gains for house prices. but economic uncertainty here and geopolitical risks overseas remain a drag on confidence, so the rebound will likely be in small steps.
And that’s the market update from Bendigo Bank.