Tim Hext: Is Inflation creeping higher? Are rate cuts over?

What does today’s jump in inflation mean for investors? Pendal’s head of government bond strategies TIM HEXT explains

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THE narrative driving the Reserve Bank and markets this year is that well behaved inflation allows cash rates to slowly move back to neutral.

The exact timing and speed, and indeed where neutral is, would be set against the backdrop of the other key RBA objective – employment.

The RBA recently updated its year-end inflation forecasts to 3% headline and 2.6% underlying (or “trimmed mean”).

So you might expect today’s monthly CPI numbers – 3% headline and 2.6% underlying –to be greeted with a shoulder shrug.

The numbers are volatile but all seems on track.

Monthly CPI indicator

However, detail in the report has unsettled some and caused upward revisions to third-quarter CPI estimates.

These numbers are released at the end of October.

Reason to doubt key inflation components

We have flagged for some time our scepticism around several key inflation components.

The main one was new dwelling costs, which had been been flatlining this year.

These make up 8% of CPI and now appear to be moving up again, possibly back above 3% annually. This alone could add 0.2% to overall trimmed mean.

The ending of electricity subsidies is pushing headline inflation higher, but of course these get trimmed as they did when pushing prices lower.

However, second round impacts of higher prices will be caught across several items which will not be trimmed.

Where we’re headed

What does this mean for year end?

When the RBA sits down on November 4 – despite downsizing from 11 to eight meetings they have sadly retained the Melbourne Cup day meeting – the board will have just received these Q3 CPI numbers. They will also release a new set of forecasts.

We expect Q3 headline CPI to be 1% headline and 0.8% trimmed mean.

Some market forecasts have moved as high as 1% trimmed mean after today’s numbers. Others are as low as 0.6%.

The first six months of this year saw 1.6% headline and 1.3% trimmed mean.

We now expect 1.5% for both headline and underlying in the second half.

If we are right the RBA will likely have to revise its forecasts up – we expect by 0.1 or 0.2%.

I think 0.1% would leave a November rate cut door open. But a 0.2% higher revision would be a harder sell for cutting rates.

What does it mean medium term?

Over the medium term, inflation should settle down in the 2.5% to 3% range, something we have expected for a long time.

This wouldn’t rule cash-rate moves in or out. Rather it would fall to employment markets to determine whether higher or lower rates were needed.

Overall we still expect a November rate cut, but we are patiently waiting for some decent entry levels to reflect the risk/reward.

Markets after today have moved the odds down to around 50 per cent, which is beginning to look interesting.

The RBA would like to give the consumer some more encouragement into Christmas.

They will have to wait till the Q3 CPI numbers to see if inflation allows it.

If you’d like to hear more about how Pendal’s Income & Fixed Interest team is positioning for this environment, please contact us through our accounts team

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.

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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