RBA: Rapid cooling inflation, a watershed event to favor a status quo in February

Towards the end of 2023, inflation has finally begun to stabilize in Australia since the Reserve Bank of Australia (RBA) hiked by 425 bps from early 2022. In fact, the rapid deceleration in the headline CPI from +5.4% YoY in Q3-23 to +4.1% YoY in Q4-23 came as a surprise for the financial markets (Chart 1). In addition to goods inflation, the sharp decline in services inflation from +5.8% YoY to +4.6% YoY contributed to stabilizing inflation in Q4-23 which should be a relief for the RBA which was concerned with sticky inflation in services. As a consequence, inflation eased faster than the Reserve Bank expected on the November Statement on Monetary Policy.

Despite of deceleration in CPI, inflation pressure continues to be relatively strong. In fact, the labor market remains tight, lifting wage pressure. The unemployment rate was still very low at 3.9% in December-23, below the non-accelerating inflation rate of unemployment (NAIRU) which is estimated between 4.5% and 5.0% by the Australian Treasury. With this background, Governor Bullock has stated that inflation is homegrown, and demand driven. Hence, the RBA could consider additional tightening, as inflation is still well above its 2-3% target range.

However, further rate hike to contain inflation could trigger a recession. After the RBA tightened aggressively to stabilize inflation, higher mortgage payments, which is estimated by the Reserve Bank to rise to about 10.5% of household disposable income, have errored consumers’ purchasing power. These developments have weakened retail sales on the back of falling consumer confidence (Chart 2).

Therefore, the RBA is expected to remain on hold at the February meeting with a hawkish stance. In fact, to carefully manage the delicate balance between sticky inflation and recession, a status quo could be a wise decision for the RBA. As the Fed turns dovish, a stronger Aussie could help further stabilize inflation in Australia.

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