RBA interest rates countdown: Low inflation number could result in February rate cut

Having observed a slight, but expected rise in the unemployment rate last week (up 0.1 percentage points to 5.4%) the RBA will next turn its attention to the December quarter inflation reading put out by the ABS next week on Wednesday (January 23).

Apart from the monthly unemployment figure, the quarterly CPI reading is perhaps the most keenly watched statistic by the RBA given that the aim of monetary policy settings are to maintain an average medium-term inflation rate of between 2% and 3%.

Inflation is viewed as a forward-indicator of demand, allowing the RBA to reduce the cash rate if inflationary pressures are diminishing to provide a “short-term stimulus to economic activity”.

For the RBA to continue to cut the cash rate this year, the inflation rate will need to continue to hover towards the lower end of the central bank’s target band.

Economist and the RBA will focus on the ‘underlying’ or ‘core rate’ of inflation reading rather than the overall headline rate.

Core inflation gives a long-term trend picture of inflation by excluding volatile, seaosonal components of CPI like automotive fuel and some food items.

An average of the trimmed and weighted inflation readings provided by the ABS gives the core inflation reading.

The major banks are forecasting a moderate rise in both headline and core inflation, which will give the RBA scope to cut the cash rate further – but a March rate cut appears more likely at this stage than one in February.

NAB and ANZ expect a core inflation reading of around 0.7% for the quarter equating to an annualised rate of 2.4% to 2.5%.

According to NAB, a low core reading of 0.6% for the quarter is needed to sway the RBA to cut the cash rate in February rather than March.

“While a February rate cut will be discussed at the next board meeting, they already have done a lot. A low core CPI would probably be needed.

"We see the tipping point at 0.6% or lower (or 0.5% ex carbon). Hence we still see a March cut as more likely but it will be a close run thing," says NAB.

ANZ expects the RBA to leave the cash rate on hold in February, but that a moderate inflation reading will give the RBA the scope to lower rates further over the year.

The bank expects a 25 basis point rate cut in March with the cash rate falling to 2% by the end of this year.

“The improvement in financial market sentiment and, tentatively, the global backdrop is likely to stay the RBA’s hand," says ANZ.

“However, given confirmation of softness in the Australian labour market this week and few signs that interest-rate sensitive parts of the economy are picking up strongly, an unusually low fourth quarter underlying CPI inflation print next Wednesday would ensure an interesting discussion by the RBA Board."