High inflation knocks out rate cuts

From Challenger Chief Economist Dr Jonathan Kearns

Australian inflation released today came in higher than expected, leading financial markets to push back the first rate cut by the RBA. Inflation was 1% in the March quarter, and 3.6% over the year.

Of particular concern for the RBA was that while annual inflation for tradable goods and services fell to 0.9%, for non-tradable items it was still 5% indicating that domestic price pressures remain strong. Non-tradable inflation has been comfortably above 1% in each of the past three quarters, suggesting there is little disinflationary impetus in domestic costs. With the labour market still tight, monetary policy has gained limited traction in reducing demand.

One place domestic price pressure continues to show up is in rent inflation which was 7.7% over the year, remaining around the highest rates of rent inflation seen in the 30 years the RBA has been targeting inflation. Since the onset of the pandemic advertised rent on available dwellings have increased by 50%, while rents on the stock of rented properties in the CPI have only increased 13%, suggesting that CPI rent inflation will remain strong for some time.

Trimmed mean inflation, the RBA’s highest profile measure of assessing the price pressures in the economy, was 4% over the year. This higher than expected reading suggests the RBA is likely to revise higher its inflation forecasts when they are released next month. While the path of inflation back to 2.5% was never going to be smooth, this quarter’s strong inflation demonstrates that even if the economic risks around the RBA’s forecasts might have been balanced, the policy risks are certainly not. The risks to easing too soon, and so eroding inflation’s return to target, are significant and so it’s appropriate that the market now does not expect the RBA to cut rates this year.