Australia’s consumer price inflation (CPI) eased to its lowest level in three and a half years in the third quarter of 2024, marking a crucial point for the Australian economy as it aims to return inflation within the Reserve Bank of Australia’s (RBA) target range. According to data from the Australian Bureau of Statistics (ABS), CPI rose by a subdued 0.2% for the quarter, pulling annual inflation down to 2.8% from 3.8%. This is the first time in three years that inflation has fallen back within the RBA’s preferred 2-3% range, aligning with analysts’ expectations. However, core inflation remains “sticky,” with key service sectors continuing to exert price pressure.
The report presents a mixed picture for the economy, where consumers saw benefits in areas like energy and fuel due to government rebates, even as services inflation – a focal point for policymakers – remained a concern. The findings have kept market reactions muted, with the Australian dollar edging up slightly and investors reassessing the likelihood of future interest rate cuts by the RBA.
Despite the headline CPI’s return to the target band, underlying inflation pressures remain persistent. The trimmed mean, a measure that excludes volatile items to provide a clearer view of inflationary trends, showed a quarterly increase of 0.8%, slightly above forecasts. Annually, this measure saw a slowdown, easing to 3.5% from 4.0%, which is a positive sign but still above the RBA’s upper target limit.
Stephen Smith, a partner at Deloitte Access Economics, emphasized that “the price pressures that remain in the economy, such as those on rents, insurance premiums, and medical services, are predominantly supply-side issues.” Smith argued that further increases in the cash rate may have limited effectiveness in addressing these areas, which are less sensitive to interest rate adjustments. “Our view is that the rate hikes have achieved their goal in curbing demand-led inflation, and further hikes may not be necessary,” Smith added.
A significant driver behind the easing in headline inflation was a sharp 17.3% drop in electricity prices during the quarter, attributed to government subsidies aimed at alleviating cost pressures for households. Additionally, petrol prices fell by 6.2%, further supporting a decrease in inflationary pressure. These developments provided a degree of relief for Australian households, who have faced higher living costs across many other categories over recent quarters.
The relief brought by lower energy prices is timely, as it comes amid rising household costs in non-discretionary areas. However, policymakers are mindful that these subsidies may only provide temporary relief, as underlying inflation, driven by services such as healthcare and insurance, continues to exert upward pressure on overall costs.
The market response to the ABS report was muted, with the Australian dollar seeing a modest increase of 0.1%, trading at $0.6569 against the U.S. dollar. Three-year bond futures slipped by a single tick to 96.06. Investors scaled back their expectations for a December rate cut by the RBA to 26%, with a slight increase in probability for an early 2024 cut, indicating that investors see April as the most likely time for the RBA to begin easing monetary policy.
“The market’s expectation of a rate cut by April suggests that they anticipate the RBA will respond as soon as the inflation picture stabilizes within the target range,” noted Abhijit Surya, an economist specializing in Australia and New Zealand at Capital Economics. “While quarterly trimmed mean CPI isn’t yet at a rate consistent with the RBA’s goals, it’s expected to align soon, possibly by the RBA’s meeting next February.”
While consumers have enjoyed some relief from subsidies and lower fuel costs, services inflation remains problematic, with a quarterly increase of 4.6% compared to the 4.5% recorded in June. This sustained elevation in service prices underscores a potential challenge for the RBA, as the central bank grapples with inflation that stems less from domestic demand and more from supply constraints in specific industries.
For example, rising rents and healthcare costs contribute significantly to services inflation. The RBA has previously identified these as areas resistant to interest rate adjustments, and they may well need alternative approaches, such as fiscal policy interventions, to bring costs down.
Despite the encouraging developments in headline inflation, the RBA has signaled a cautious approach. The central bank, which has kept its cash rate steady at 4.35% since November, believes that the current rate is sufficiently restrictive to contain inflation while maintaining employment gains. The resilience of the labor market, with unemployment rates remaining low and wage growth relatively stable, supports the RBA’s stance against premature easing.
However, some analysts argue that the current trajectory of core inflation may provide room for the RBA to begin rate cuts by the first quarter of next year, aligning with expectations for inflation to settle closer to the RBA’s target.
The data from September alone suggests further positive signals for inflation, with CPI rising by just 2.1% year-on-year, the lowest monthly increase since July 2021. Similarly, the trimmed mean measure for September decelerated to 3.2%, edging closer to the RBA’s target band. These figures underscore a potential easing of inflationary pressure in the short term, which could reinforce the case for rate cuts in 2024.
Nevertheless, some economists caution against too much optimism, as global economic uncertainties, including elevated energy prices and geopolitical tensions, could reintroduce inflationary pressures.
For Australian consumers, the slowing inflation rate provides a welcome respite following months of high costs in essential categories. While energy subsidies have temporarily reduced household expenses, the continued pressure in the services sector means that the cost of living remains challenging for many.
On the business front, easing inflation may offer relief to firms that have grappled with higher input costs. However, service-based sectors such as real estate, healthcare, and insurance may continue to pass on higher costs to consumers due to supply-side constraints and sector-specific pressures.
The RBA’s next policy meeting will be a focal point, as it will incorporate updated economic forecasts that take into account the latest inflation data. While the central bank has been steadfast in its rate policy, citing the need to keep inflation within the target range, the gradual easing in core inflation suggests that the RBA may reconsider its stance in 2024.
“The RBA’s cautious approach reflects a broader goal to maintain economic stability while guiding inflation back within the target,” noted Surya. “Should inflation continue to ease as expected, we foresee a gradual path to rate cuts, potentially beginning in the first half of next year.”
