Dr Shane Oliver, Head of Investment Strategy & Chief Economist at AMP, discusses interest rates.
The “make or break” June quarter inflation and retail sales data for Australia came in on the softer side compared to market expectations. Headline inflation rose by 1% over the quarter and 3.8% over the year, matching economists’ expectations as well as the RBA’s forecasts back in May. Meanwhile the trimmed mean (aka Australia’s core inflation reading) rose by 0.8% during the quarter (lower than consensus expectations for a 1% rise), which took annual growth to 3.9%. Inflation is still too high, but clearly we have seen continued progress in reducing inflation since the peak in December ’22, despite bumps as indicated by the monthly CPI gauge in the past few months. Retail sales data is also similar – while there was a monthly upside surprise of 0.5%mom growth mostly due to a bigger than normal boost from end-of-financial-year promotions, the quarterly retail volume actually contracted 0.3% and has gone backwards for 7 out of the last 8 quarters.
Inflation still remains too high and justifies keep rates at a restrictive level for now. The biggest contributors include the following:Housing prices which rose 1.1%qoq, driven by both rents & new dwelling purchases. Rent prices rose 2.0%qoq or 7.3%yoy, reflecting an extremely tight rental market even with some moderation from the Commonwealth Rent Assistance. However, the pace of rent growth has moderated from the peak last quarter and asking rent growth has come off its peak, so we continue to see housing inflation slowing somewhat in the next few quarters.Insurance prices rose 3.1%qoq or 14% over the year, reflecting natural disasters, higher reinsurance costs and higher replacement costs for cars, medical equipment or other household goods that we have already seen in the past 2 years. With goods inflation slowing, this should eventually be reflected in slower insurance price hikes as well.Education prices rose 0.9%qoq or 5.6%yoy – the highest annual rise in a decade – driven by higher indexation of tertiary & secondary education to the previous financial year’s inflation figure (they rose 7% and 6.1% over the last year, respectively).Health prices were up 1.5% over the quarter or 5.7% over the year – reflecting the annual increase in private health insurance premiums.Tobacco & alcohol (+6.8%yoy) and automotive fuel (+7.7%yoy) were the goods that recorded the largest price rises, leading to a small rebound in annual goods inflation after 6 consecutive quarters of falling. However, this also reflects the recent indexation for tobacco to wages growth & the new alcohol excise increase in February.However, many of these items – notably in education, health and tobacco – reflect prices administered by government or which are indexed to past CPI increases which the RBA should arguably look through.
Source: ABS, AMP
Source: ABS, AMP
This following chart shows the inflation rate for items with a high degree of government intervention (such as health or utilities prices) or have prices indexed to historical inflation rates (for example education and tobacco) in red. As a result, they lag market prices of other items in the inflation baskets (in blue) so it is likely they will tick down in the upcoming quarters.
Source: ABS, AMP
It is also notable that discretionary spending demand has been lacklustre, evidenced by inflation in discretionary items (ie. items that can be considered “optional” such as restaurant meals, clothing, travel) being already in the RBA’s target band (+0.8%qoq or +2.8%yoy). Meanwhile non-discretionary or essential item inflation which includes foods, petrol, housing and health costs remains higher at 1.1% quarterly pace or +4.5% annual pace.
Source: ABS, AMP
Out of interest, the categories that have had the largest growth in prices in the last 10 years have been in the “painful” essential services areas like insurance, gas, housing construction costs, health and education. These are also areas that have a lot of government influence.
Weak demand is also evidenced in today’s retail sales data, with retail volumes declining 0.3% over the quarter or 0.6% over the year. Real retail spending per person is also trending down, declining 3% over the year and has gone backwards since 2022. The current “retail recession” continues to be one of the most significant both in terms of length and magnitude.
Source: ABS, AMP
Indeed May and June nominal sales surprised us on the upside (+0.5%mom against expectations for a 0.2% rise), but this came in the context of restrained spending from shoppers in the past few months and now they are taking advantage of mid-year promotions in furniture, electrical goods and clothing – which explains the rise in the blue line below. Hanging out for sales discounts is actually a sign of consumer weakness. Meanwhile, food spending is still very stable (as it’s an essential item), while discretionary spending on dining out continues to trend down even with strong population growth.
Source: ABS, AMP
Overall, our thesis remains unchanged that a restrictive cash rate in Australia continues to work in dampening demand, and that forward looking indicators for inflation are also showing continued progress (albeit with some spikes in PMI surveys that are also related to Australia’s indexing of many price contracts to previous inflation in July). While our inflation rate remains higher than many developed countries, it has ticked down at a similar pace following leads from the US, Eurozone, Canada and the UK. Australian inflation lagged on the way up so its understandably lagging on the way down, but the US experience with hotter inflation data earlier this year and now colder inflation data suggests Australia will see something similar.
Source: Bloomberg, ABS, AMP
Our assessment remains that the RBA’s cash rate has peaked. The June quarter inflation data was roughly in line with RBA expectations and well below feared levels for the trimmed mean that might have triggered another high – say 4.1%yoy or more. While inflation is still too high the RBA will be mindful that monetary policy remains restrictive, the full impact of past rate hikes is still feeding though, recession risks remain high with real retail sales per capita down again in the June quarter and down 3%yoy, forward looking jobs indicators warn of rising unemployment ahead, wages growth has peaked which will slow services inflation and inflation is likely to fall sharply this quarter as “cost of living” measures impact making for difficult optics in trying to explain another rate hike. What’s more, the US experience with hotter inflation earlier this year now giving way to cooler inflation again adds to confidence that Australian inflation will start to fall again and the Monthly Inflation Indicator which slowed in June may be indicating this.
So, all up we expect the RBA to leave rates on hold at its meeting next week, albeit with a mild tightening bias, ahead of rate cuts starting next February. The money market which was attaching another 70% chance to another rate hike has now swung full circle, pricing in some chance of a cut in future meetings with a cut now fully priced in by February next year.
Ends
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