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Lowest Inflation Rates in 100 Years will see RBA Cut Rates

Many economists are expecting an August rate cut subject to this week’s June CPI figures being in line with market expectations. Westpac’s Bill Evans was representative of most of his peers when he said prior to the release of the June quarter CPI figures, “I think it is therefore reasonable to conclude that a 0.5% figure for underlying inflation, although representing a sharp jump from March’s 0.2% would be consistent with a follow up rate cut at the August meeting.”

The numbers have now been published and they were basically as expected and the lowest since 1998. The headline consumer inflation rate was 0.4% for the quarter and 1.0% for the year (1.1% expected). The biggest contributors to inflation were higher health, fuel and housing-related costs. The core measure of inflation, which strips out volatile components such as fuel, fruit and vegetables, rose 0.3% for the quarter and 1.6% for the year.

Cash market futures contracts reduced the probability of an August cut from 57% to 51%, suggesting markets are not as confident as economists of a rate cut at the next RBA meeting (on 2 August), but still view the chances of a cut as just as likely as not. Local bond yields moved a tad higher while the response in currency market was to bid up the price of the local currency to 75.60 US cents before it quickly settled back, indicating financial markets viewed the numbers as supportive of higher interest rates, at least initially.

Here’s what the economists thought:

Michael Blythe, Commonwealth Bank

“Inflation is low whichever way you cut the numbers. Headline inflation is running at the slowest pace since mid-1999. Underlying inflation is running at a record low. Inflation in the first half of 2016 ran at 1.25% (annualised) or well below the RBA’s 2%-3% target band. While the RBA will probably cut in August, taking the cash rate to a new record low of 1.5%, we suspect that they will do so through gritted teeth. It is arguable that the domestic economy is in need of any additional stimulus at this point. There is a respectable line of argument that further rate cuts may not help. And that cuts may just add fuel to the housing market.”

Scott Haslem, UBS

“On balance, we believe today’s CPI is enough to get the RBA across the line for a (final) cut in August, but the lack of downward surprise today and better recent data, makes this a closer call.”

Annette Beacher, TD Securities

“Recall the May minutes revealed that some members saw a case for waiting to cut: they could ‘see cases both for moving at this meeting or at the subsequent meeting’. With a lack of a shock in either inflation or key activity indicators, there really isn’t a clear trigger for a cut next week.”

David De Garis, NAB

“The revelation that the underlying CPI was not another repeat of the first quarter when growth was an anaemic 0.2% but pushed up this quarter to 0.5% had the market rethinking and repricing whether the RBA was indeed more likely than not to cut rates again next week. NAB’s assessment is that the CPI was right in line with RBA May SoMP forecasts and likely sufficient to see them remain on hold next week.”

Josh Williamson, Citigroup

“The yearly underlying CPI result of 1.5% is directly in line with the RBA’s forecast from the May Statement on Monetary Policy. We had previously said that it would take a downside surprise from this forecast to get the RBA cutting the cash rate next month. We now push our forecast for a 25bp cut out to the November RBA meeting.”

Craig James, CommSec

“The only way that the Reserve Bank can seek to lift the inflation rate to the target band is by running the economy at a faster rate and that means cutting interest rates. So a rate cut will be on the agenda at the Reserve Bank Board meeting next Tuesday. Will a rate cut actually boost growth? It is far from certain, but the Reserve Bank has to try. But the Reserve Bank won’t continue to cut rates if it’s clear that interest rates at super-low levels have become ineffective in boosting demand.”

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