Tim Hext: Rate hikes off, rate cuts on in 2025

Today’s inflation numbers mean the rate-cut window is open in Australia from early next year. Pendal’s head of government bond strategies, TIM HEXT, explains why

• Two easings expected in February and May
• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

TODAY’S 1% quarterly CPI number would not normally be cause for celebration. After all, that’s 4% annualised – above the RBA target.

But the RBA focuses more on trimmed-mean inflation to avoid high and low swing items like petrol and food.

On this measure, the Q2 CPI number was 0.8% – still not quite in the target band, but comfortably heading that way.

Calls for rate hikes are off, the RBA can again be patient and the inflation picture should improve into year end.

Markets liked it. At the time of writing three-year bonds had fallen from 3.95% to 3.73%.

RBA governor Michele Bullock can avoid the wrath of the government and Anthony Albanese can return to selling his pre-election cost-of-living relief without a rate hike spoiling it.

Key items in the CPI: 1% headline (1% forecast) for Q2

We already had two-thirds of the items from the monthly CPI in April and May, so the headline was no surprise.

There was remarkable consistency across key areas, as food, housing, transport and insurance all went up around 1%.

In the context of these recent moves, housing and insurance were lower than previous outcomes, though there were some seasonal elements for insurance.

Health was up 1.5% as medical and hospital services grew at 2%. This is more structural and recent battles between providers and health insurance show the strains in this sector.

Tobacco was up 3% on tax indexation, which alone added almost 0.1% to CPI. International travel was up 8%, though domestic travel partly offset that – down 5%.

Trimmed (underlying) inflation 0.8% (forecast 1%) – why the forecasting miss?

Given the headline number came in as expected, why did economists miss the trimmed number, which came in at 0.8%?

At the risk of losing readers’ interest, this gets into how “trimmed-mean inflation” works.

Basically, the RBA (or ABS these days) lines up every item from highest to lowest change – weighted for its contribution to the index – and cuts off the top and bottom 15%.

That is, 30% of weighted items are trimmed.

Petrol is nearly always trimmed (it’s 3% of the CPI weight), as are many food and non-alcoholic items (a combined 17% weight).

Volatility in travel prices means they are generally trimmed these days (6% of weight).

This still leaves around 5-10% of weighted items to be trimmed and the extent of their movements feeds back into the trimmed mean.

If I’ve lost you, find your resident mathematician – there’s generally one around in finance.

Rate hikes off, rate cuts on – but not till 2025 despite a potential flat headline CPI in Q3

The RBA releases its forecasts every quarter at its early February, May, August and November meetings.

Given the lack of any guidance from the RBA these days, these forecasts are important.

In May, the RBA expected trimmed mean inflation to be 0.8% in Q2, so it will be pleased with today’s result. The inflation scares from the monthly April and May numbers, which Bullock felt the need to acknowledge at the June RBA meeting, have passed.

When we get the new set of forecasts next week, we think headline CPI will be forecast at 3.2% for year end – down from 3.8% due to electricity subsidies announced in recent Federal and State budgets.

Trimmed mean inflation, however, will likely only be revised down from 3.4% to 3.2%.

That is, trimmed mean inflation will still likely be too high for a rate cut this year, though there should be some probability priced.

About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.

Find out more about Pendal’s fixed interest strategies here

About Pendal

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

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