A February interest rate cut is a real possibility, but there's at least one hurdle to clear

At 11:31am AEDT on Wednesday, the Australian dollar began falling against the greenback. 

It went from buying 62.41 US cents to 62.14 US cents over the course of an hour or so.

Why?

Traders were pricing in a greater chance the Reserve Bank would move to cut interest rates at its February meeting, pleased with the progress made on reducing inflation to its target band of between two and three per cent.

An interest rate cut would potentially lead international investors to shift away from Australian interest rate securities in favour of US-dollar denominated assets, selling Australian dollars in the process.

That’s a fair call.

Official inflation figures show “trimmed mean” inflation continued last year.

It fell from 3.5 per cent in October to 3.2 per cent in November.

The trimmed mean measure of inflation is a smoothed measure of selected price changes in the economy.

It’s also called underlying inflation, and it gives economists a better idea of whether price pressures are easing on a more long-term basis.

To complicate things a little, the headline inflation rate — which does include the prices of goods and services that jump around quite a bit — rose from 2.1 per cent to 2.3 per cent.

The Australian Bureau of Statistics put this down to a quirk in the numbers created by state and federal government energy rebates.

Stay with me on this one.

In some states and territories, households received two rebate payments in October, in lieu of not receiving a payment in July.

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It contributed to a bigger reduction in the monthly headline October inflation number and then there was payback in the November number — because the reduction in energy costs was smaller.

But Treasurer Jim Chalmers was keen to highlight how much the government’s cost-of-living measures were helping household budget bottom lines.

“If you take electricity prices, for example, they have fallen 21.5 per cent in the year to November.

“They would have fallen 1.7 per cent without our energy rebates for every household that we are rolling out.

“So electricity prices would have come off a little bit.

“With our action they’ve come off substantially.”

But economists say elevated inflation persists within services.

Rents rose 6.6 per cent in the year to November, the cost of building a new home rose 2.8 per cent, health care increased 3.9 per cent and insurance premiums jumped 5.5 per cent.

Indeed, Shadow Treasurer Angus Taylor continues to focus attention on services inflation and the damage it’s doing to household budgets.

“And services inflation indeed is above 4 per cent,” he said.

“And all of this tells us that the government has been playing games.

“Now you don’t need to tell any Australians that. They know it.

“They see it in the bank account, they see it when they go to the check-out, they see it when they have to pay their bills.

“They are suffering.”

But let’s call all that commentary for what it is: political spin.

The government makes a valid point it’s cost-of-living measures are helping households make ends meet — especially lower income households receiving Commonwealth Rent Assistance.

Equally valid though is the opposition’s argument that inflation remains too high, and continues to hurt household budgets.

It’s especially galling that, after 13 interest rate hikes since May 2022, millions of mortgage borrowers — many of whom have only just received an increase in their real wages — are still waiting for mortgage payment relief.

But economists say part of that suffering may be coming to an end.

At its December meeting, the Reserve Bank indicated inflation was still too high but it was “gaining confidence” it was on track to return to its target band of between 2 and 3 per cent.

That word “confidence” is highly subjective. But it has become crucial to the timing of the first RBA interest rate cut.

ANZ Bank senior economist Catherine Birch says Wednesday’s inflation numbers may give the Reserve Bank more confidence it can cut interest rates soon.

“Look it is definitely a good sign and it’s always positive when inflation — particularly that trimmed mean measure — is coming down more quickly that expected,” she said.

“And it does look very likely there will be a rate cut in the first half of this year — 2025.

“But at the same time, while it would be good for borrowers when rate cuts do start our view is that there will only be two 25 basis point rate cuts in this cycle.

“And part of the reason for that is that we are seeing quite a bit of resilience in the economy, particularly in the labour market.”

That’s a crucial point.

The concern is that too many Australians are employed.

“This concept that somehow unemployment is going up so people are losing their jobs, it sort of — it misses, I think, the key point which is what we’re actually forecasting is that employment just doesn’t grow as fast as the labour force grows,” RBA governor Michele Bullock told yours truly in November.

“It’s just that those that are coming into the labour force are finding it more difficult to get jobs and they’re going on to the unemployment queue rather than into a job.”

This sort of economic environment, where it’s harder to land a job and underlying inflation is consistently easing, may well present a green light for the Reserve Bank to cut interest rates.

So additional ABS figures on Wednesday showing the number of job vacancies in November having risen by 4.2 per cent throws a spanner in the works.

It shows more employers are hungry for candidates.

Bjorn Jarvis, ABS head of labour statistics, said “While there has been a downward trend in job vacancies over the past two-and-a-half years, the number of vacancies is still 51.3 per cent higher, or around 117,000 more, than before the COVID-19 pandemic.”

The strength in the labour market — and the extra demand it creates in the economy — will be another factor for the Reserve Bank to consider next month.

It may also help explain why the Australian dollar bounced back to 62.33 US cents after the inflation data was process by market participants.

At this stage, economists say, the RBA’s February interest rate meeting will be “live” — meaning there’s a credible chance the decision will be made to cut interest rates for the first time since May 2022.

All eyes will now be on the release of the unemployment rate for December on January 16, and the December quarter inflation data on January 29.

An interest rate cut is agonisingly close for millions of mortgage borrowers, but we’re not quite there … yet.