Australia Q2 inflation to make or break case for rate cut

Australian inflation likely braked to all-time lows in the second quarter, if analyst forecasts prove right, cementing the case for another cut in interest rates as early as next month.

When underlying inflation slowed surprisingly sharply to a record low of 1.5 percent in the first quarter, the Reserve Bank of Australia (RBA) responded almost immediately by trimming the cash rate a quarter point to 1.75 percent. ECONAU

Many analysts expect a repeat performance this time should core inflation dip to a fresh trough of 1.4 percent as forecasted in a Reuters poll. The figures are out July 27.

“Underlying inflation in line with expectations would reinforce the weak trend, and in combination with softer labour and housing markets and a relatively elevated AUD, would be sufficient reasons for the RBA to cut,” said Felicity Emmett, head of Australian economics at ANZ.

“The surprise would be a stronger-than-expected inflation outcome – which would raise the possibility that disinflationary forces are abating,” she added.

Analysts assume a quarterly increase of 0.6 percent or higher might give the RBA reason to pause, while a result of 0.4 percent or less would seal the deal on an easing. A rise of 0.5 percent would make the call a close one.

The central bank looks at several measures of core inflation but the market tends to focus on the trimmed mean and weighted median, which strip out the largest falls and rises in any quarter to try and find the underlying pulse.

The headline consumer price index (CPI) can be thrown around by changes in a few sectors, such as petrol and fresh fruit which were major drivers of a rare 0.2 percent drop in the first quarter. The CPI is seen rising 0.4 percent in the second quarter, though the annual pace would still slow to 1.1 percent.

There are more fundamental forces behind the slowdown, including a global excess of supply over demand, a relatively resilient Australian dollar and record-low wages growth at home.

Adding to the disinflationary trend is a price war in the retail sector as foreign entrants shake up the market and weakness in rents amid a record pipeline of new apartments.

The longer this lasts the greater the danger of it becoming baked into firms’ price and pay decisions, a negative feedback loop that has already taken hold in neighbor New Zealand where annual inflation slowed to just 0.4 percent last quarter.

“Given our view that structural disinflationary forces have likely intensified in Australia, and the RBA’s revealed concern about the risk of persistent low inflation, we now look for another cut in August,” said Scott Haslem, an economist at UBS.

Source: Reuters