Inflation back in target range, is the fight over?
The third-quarter consumer price index (CPI) released this week helped firm the outlook for the trajectory of inflation and the likely timing of interest rate cuts.
The release confirmed inflation is continuing to move lower, but the detail reveals not by enough to change the RBA's stance on policy.?
Over the 12 months to the September 2024 quarter, the CPI rose 2.8%. It was the lowest annual rise since the March quarter of 2021 and well below the 7.8% peak at the end of 2022. Price declines for electricity (-17.3% quarter-on-quarter) and petrol (-6.7% quarter-on-quarter) subtracted a combined 0.65 percentage points (ppt) from the quarterly outcome.
While technically within the Reserve Bank’s 2% to 3% target range, those looking out for an interest cut this year are likely to be disappointed.
February 2025 is likely to be the earliest we could see rate cuts beginning but given the strength of the labour market and stickier components of inflation, this timing could be pushed to May. Although headline inflation continues to trend down, the recent falls have been aided by electricity rebates and other cost of living relief measures offered by the federal and state governments and are therefore not reflective of underlying price pressures.
? As a result, the RBA will look through the decline in headline CPI and focus on still too strong underlying inflation. Short of an external shock or substantially higher unemployment and lower underlying inflation, the RBA is likely to remain on hold in the months ahead as the board looks to sustainably return inflation to the target range.
The RBA is of the view that the level of demand in Australia is too high relative to supply. Inflation has been trending down since late 2022 and although headline inflation has fallen back to the upper end of the RBA’s 2-3% target range, underlying inflation pressures remain too strong, allowing the RBA to look through the fall in headline inflation.
The RBA's preferred measure of underlying inflation, the trimmed mean CPI, rose by 3.5% year-on-year in Q3, easing from the 3.9% annual rise posted in the previous quarter. This puts underlying inflation at the lowest level since the end of 2021. Despite the decline, underlying inflation pressures remain persistent.
Market services inflation remains high and above average levels, reflecting still too strong domestic inflationary pressures, another focus for the RBA given its persistence. The CPI reflects that although restrictive monetary policy continues to bring demand and supply more into balance, there is further to go.
As a result, conditions warranting rate cuts are very unlikely to arise before the end of the year. February 2025 is likely to be the earliest, though this could be pushed to May pending further updates on inflation and employment. Current market pricing has pushed the timing out to June 2025.
Although the exact timing of interest rate cuts next year remains uncertain, the expectation is that while rates are set to remain on hold in the months ahead, they will move lower next year.
This uncertainty around the timing of rate cuts likely remains a concern for some buyers, but others may look to pre-empt the move lower and transact now with the expectation of continued price rises motivating sooner purchase activity.
Historically, before interest rates begin to move lower has been viewed as a good time to buy, we typically see home prices lift with buyer confidence and borrowing capacities boosted as rates fall.
Though prices are likely to move higher as interest rates move lower next year, given the stretched starting point for affordability, the price uplift could be more muted compared to prior easing cycles.
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As inflation trends downward, moving sustainably into the RBA’s target range, this will enable the RBA to begin cutting interest rates, starting at best in the first quarter of next year.
October is the peak of the spring selling season with listing activity at its strongest, this increase in the number of properties listed for sale typically translates to increased activity with buyers enjoying the uplift in choice.
This spring selling season has been busy with auction volumes and listings activity outpacing levels seen this time last year. So far buyers have taken advantage of this increase in choice and housing demand has remained resilient, defying affordability constraints with prices lifting across much of the country in October.
Home price growth has reaccelerated after slowing through winter and early spring, with national prices lifting 0.26% in October - the 22nd consecutive month of growth - to sit almost 6% higher than a year ago.?
Despite price growth regaining momentum in every capital except Brisbane, Adelaide and Darwin in October, it remained below the pace seen at the end of the summer selling season, as buyers enjoy more choice. The pace of growth also remains varied with differing supply and demand conditions driving diverse performance across the country.
Supporting price growth at present and in the period ahead, July’s tax cuts boosted borrowing capacities and buyers’ budgets, while the persistent growth in home prices is likely motivating many to overcome affordability challenges. Strong population growth, tight rental markets and home equity gains also continue to bolster demand.
Meanwhile, building activity remains challenged, exacerbating a chronic shortage of housing.
Though home-price growth regained speed in October, sustained high interest rates and affordability constraints are weighing. Buyers now have more properties to choose from, and uncertainty around the timing of interest-rate cuts remains. Still, prices are expected to remain on the rise as the busier selling season closes out.
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