Tim Hext: Inflation on track but still too high

The door may open for the RBA to pass three cuts next year, but that may be “as good as it gets”, writes head of government bond strategies TIM HEXT

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THE ABS released new inflation data today and – in the spirit of more information – it seems there are now more numbers to watch than before.

The most watched are the quarterly numbers – that is, the September quarter versus the June quarter.

These showed headline inflation at 0.2%, courtesy of electricity subsidies and lower fuel prices. Against the September quarter last year, prices are 2.8% higher.

Also released were the September monthly numbers.

This compares prices for September 2024 versus September 2023. Here, the news was even better, with headline prices only 2.1% higher over the year.

However, the ABS tries to strip out the noise of volatile prices by reporting trimmed mean inflation, Australia’s version of underlying inflation. The highest and lowest 15% of moves (weighted for size in the CPI basket) are excluded.

Here, the news is mixed.

Trimmed mean inflation for the quarter was 0.8% and 3.5% versus the September quarter last year.

This is heading lower, but the RBA would need to see consistent prints 0.7% or lower to feel comfortable about inflation being sustainably in its target band.

Source: CPI rose 0.2% in the September 2024 quarter | Australian Bureau of Statistics

The path ahead

So, where exactly is inflation and what path is it on? And what is the RBA reaction function?

The RBA will keep talking about services inflation being uncomfortably high. The pace of last quarter showed no improvement, stuck at 4.5%.

Services make up around two-thirds of the CPI basket, so clearly that needs to be nearer 4%. If we dig into services, the problem areas (those above 5%) remain housing, health, education and insurance.

As wage growth moderates with inflation, there is some cautious optimism that education inflation should drift back to 4%. For example, NSW teachers just signed a three-year wages agreement of 3% per year plus 1% more super.

Housing is more mixed. State government spending on infrastructure continues to create labour shortages in construction, impacting both rents and the cost of new dwellings. In this area, 5% inflation may be here to stay for a while.

Insurance premium rises should moderate but may also struggle to fall through 5%.

Health prices remain impacted by massive labour shortages and readjustment of wage levels in the care sector. Again, this is driven by government policy.

Putting it all together

When we put this together, the path for inflation looks like hitting 3% (underlying) early next year but remaining stuck around that point.

This means that the RBA will have a door open to cut rates, though it will be driven by employment markets and the size of cuts globally.

We remain optimistic that this will allow for three rate cuts next year.

However, without some external shock hitting the economy, that may be as good as it gets.

Market pricing has not budged with this number. A February rate cut is priced at a 50% chance, with a full cut not priced till May 2025.

This places the odds slightly in favour of a long-duration position, though US election fears are keeping volatility high and risk size modest.

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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