Australia's inflation hits 3.5-year low, greenlighting July rate cut

Australian consumer price inflation slowed more than expected in May, while the closely watched core measure hit three-and-a-half-year lows as investors locked in bets for an imminent rate cut.

Swaps now imply a 92 per cent probability that the Reserve Bank of Australia would cut rates by a quarter-point when it delivers its policy decision on July 8, a day before the expiry of a 90-pause in US reciprocal tariffs on other countries. That was up from 81% before the data.

Commonwealth Bank of Australia, Deutsche Bank and TD Securities changed their next rate cut call to July from August, while UBS said its expectation for the RBA to hold steady next month is under review.

Wednesday's report showed services inflation slowed to an annual rate of 3.3 per cent, from 4.1 per cent the previous month, while rents rose 4.5 per cent, the lowest annual growth since December 2022.

"Today’s monthly CPI print capped off a flow of data that should provide comfort to the RBA that a swifter return of the cash rate to neutral is both manageable and needed," said Belinda Allen, a senior economist at CBA.

"Maintaining the current restrictive settings for too long raises the risk of inflation undershooting the midpoint."

Data from the Australian Bureau of Statistics on Wednesday showed the monthly consumer price index (CPI) rose 2.1 per cent in May compared with a year earlier. That was down from 2.4 per cent in April and under median forecasts of 2.3 per cent.

In the month, CPI fell 0.4 per cent from April as petrol prices eased and housing costs cooled.

Crucially, the trimmed mean measure of core inflation increased at a slower annual pace of 2.4 per cent in May, coming under the mid-point of the 2-3 per cent target band. That was down from 2.8 per cent in April and also the lowest reading since late 2021.

"We are convinced that the RBA needs to cut in July to safeguard growth as inflation is clearly out of their way now," said Krishna Bhimavarapu, APAC economist at State Street Global Advisors.

"We are tracking faint consumption and growth in Q2, and hence, the bank may do well to frontload the cut to July."

The RBA has cut interest rates twice since February to 3.85 per cent as cooling inflation at home offered scope to counter rising global trade risks. However, the economy barely grew in the first quarter as consumers stayed stubbornly frugal on heightened worries about the economic impact of US tariffs and geopolitical conflicts.

All of that argued for more policy easing from the RBA in the months ahead, with investors expecting a total easing of 78 basis points by the end of the year.

The labour market has so far stayed resilient. The unemployment rate remains low at 4.1 per cent and job advertisements are stabilising above pre-COVID levels. Wages have been well-behaved, with growth in the private sector mostly subdued.

New dwelling prices were flat in the month, while holiday travel and accommodation prices fell 7 per cent after a 6 per cent rise in April, which was driven by holiday demand.

Meanwhile Australian household spending rose only marginally in April, data showed on Thursday, a further sign consumption was still lagging income growth despite a drop in borrowing rates and cooling inflation.

The Australian Bureau of Statistics’ monthly household spending indicator (MHSI) showed a seasonally adjusted rise of just 0.1 per cent in April, after a dip of 0.1 per cent in March.

Household spending for April fell in four of the nine categories measured by the ABS, with notable declines in clothing and tobacco and alcohol.

“Spending on goods fell by 1.1 per cent, with households buying less clothing and footwear and new vehicles,” noted the ABS.

“Spending on recreational and cultural activities, health, and dining out contributed to a 1.5 per cent rise in services spending.” Annual growth slowed a fraction to 3.7 per cent, a historically miserly pace particularly given solid population growth of around 1.7 per cent.

Household spending comprises around 52 per cent of gross domestic product but made only a minor contribution to growth in the first quarter when the economy expanded by a meagre 0.2 per cent.

The Reserve Bank of Australia (RBA) already had to slash its consumption forecasts when it cut interest rates by a quarter point to 3.85 per cent in May, and will now likely have to downgrade the outlook even further.

Markets are wagering the RBA will ease again as early as July, and see rates bottoming around 2.85 per cent by early next year.

Agencies