Tim Hext: Inflation data ‘good news’ for the RBA

The door is wide open for modest rate cuts as inflation settles back to around 3 per cent, argues Pendal’s head of government bonds, TIM HEXT 

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AUSTRALIA’S latest quarterly inflation figures offer good news to both the Reserve Bank and the Albanese government.

Headline CPI came in at 0.2% for the quarter, now 2.4% year-on-year (yoy). Trimmed mean inflation, our version of underlying inflation, came in at 0.5% and 3.2% yoy.

In November, the RBA had forecast inflation at 2.6% and trimmed mean at 3.4% for the end of 2024, so these numbers are a 0.2% improvement on recent expectations.

More important, though, is the significant improvement in several key areas that show it is not just a story of government subsidies artificially lowering inflation. Subsidies directly likely only kept trimmed mean inflation around 0.1% lower as the large falls are trimmed away.

New dwelling costs were one of the poster children for runaway inflation through the pandemic. Labour shortages and massive homebuilder subsidies saw 10% annual growth for several years.

Prices have now plateaued and even slightly fell in the quarter, as it has shifted from a sellers’ market to a buyers’ market. These constitute 8% of the CPI basket so they can make a big difference.

The other key area of housing is rents, which are 6% of the CPI basket. These went up only 0.6% on the quarter and were dampened by a 10% increase in rental assistance to the 1.5 million people who receive it.

Nevertheless, the underlying pulse for rents is now heading nearer 5% than the 8-10% of the past few years. These two key areas are partly behind services inflation, falling from 4.6% to 4.3%.

If services (two-thirds of CPI) can settle around 4% with goods prices (one-third of CPI) nearer 1%, then the RBA should be more confident of medium-term inflation being within its 2-3% target, albeit more at the top end of its range.

Finally, as you would expect with falling inflation, the number of components rising faster than 3% is now down to 37% from around 85% in late 2022.

This graph, courtesy of NAB, shows that only 42% of items are over 2.5%. This is not weighted, but speaks to the breadth (also called diffusion) of price disinflation.

All this leaves the door very wide open for an RBA cut in February. The market is now 90% priced and has another rate cut priced by May and a third by August.

We agree with the first two, but caution against pricing too many more beyond that.

Inflation will push back nearer 0.7% in Q1 CPI, due in late April. However, large government spending here, both Federal and State, will continue to keep a solid footing under growth and employment.

The RBA will need to do a twist around its estimate of full employment.

Its rates-on-hold narrative was based on excess demand versus supply in employment markets, given the 4% unemployment rate. Its estimate for full employment, where demand and supply are in balance, was nearer 4.5%.

However, with wage growth moderating to 3.5%, it points to full employment being nearer the current levels of 4%. Expect some commentary on this.

We continue to favour steeper curves and modest overweight duration positions, focusing on one to three-year part of the government yield curve as we expect both short-term bond yields to fall, while longer-end bond yields may rise or stay the same.

If not for the high level of uncertainty out of the US, our long duration views would be more confident.

Perhaps the biggest sigh of relief on the release of today’s numbers will have come out of Canberra.

A pre-election rate cut, possibly even two, would be welcomed by young people living in the mortgage belts, and often swing seats, of Australia.

In what is shaping up as a close election, any good news on the cost of living will be grabbed by Albanese and Chalmers.

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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