The Reserve Bank will likely wait until May to lower interest rates. But there's a case to cut them now

Global investment bank JP Morgan perhaps put it best in a note to clients and the media this week titled “Australian CPI: Under control”.

Domestic inflation does appear to be under control. The prices of particularly sticky items in the basket measured by the Australian Bureau of Statistics are coming off the boil.

And stronger economic growth, according to the federal budget, is reliant on a renewed confidence in the private sector struggling with high levels of uncertainty about the future.

On some measures, the Reserve Bank’s goal of lowering inflation to be within the target band of 2 and 3 per cent has been achieved.

With little risk of inflation spiking higher, the RBA could comfortably move to cut interest rates on Tuesday.

But it’s highly unlikely to do so, and it’s worth exploring why.

Progress on inflation

Significant progress has been made on reducing inflation.

Core or underlying inflation peaked in December 2022 at 7.8 per cent. The latest measure (December 2024) puts it at 3.2 per cent.

The Reserve Bank and households can all take credit for this.

Restrictive interest rates have curbed spending, reduced demand, and led to a reduction in price increases and, in some cases, discounting (deflation).

And measures of headline inflation — which includes so-called “volatile” items in the basket of goods and services measured by the ABS, look even better.

In the December quarter, annual headline inflation fell to 2.4 per cent, which is within the RBA’s target band.

The ABS’s Monthly Inflation Indicator (February) shows headline inflation at 2.4 per cent, and core inflation at 2.7 per cent.

Again, all within the Reserve Bank’s target band — although the monthly data sets are widely recognised as being insufficient to make a conclusive call on trend inflation.

However, taken with the above data, monthly inflation certainly supports the argument that inflation is “under control”.

Disinflation taking hold

The reason prices, more broadly, are not rising as fast now as they have been, is simple. The so-called “sticky” items in the ABS basket — including rental prices, the cost of building a new home, insurance premiums and out-of-pocket healthcare costs — are all looking less sticky.

Rental price growth, for example, has fallen to 5.5 per cent in the 12 months to February. It was above 6 per cent last year.

Insurance prices rose 7.6 per cent in the 12 months to February, while insurance price growth has continued to soften from its peak of 16.5 per cent 12 months ago.

And out-of-pocket healthcare costs, with an inflation rate of 4 per cent, have remained unchanged now for months.

Petrol has gone from inflationary to deflationary.

The one item in the basket that stands out is electricity.

Indeed, trimmed mean inflation of 3.2 per cent recorded in the December quarter “excluded the falls in both electricity and automotive fuel, alongside other large price rises and falls”, the ABS said.

This is because the price reductions, in the case of electricity, were largely engineered by the government.

The Reserve Bank rises above all of this. It says it wants to see underlying or “core” inflation sustainably within the target band.

For this to happen, it says, total or aggregate supply in the economy needs to be greater that total or aggregate demand.

Hot or not?

Surely this (supply outstripping demand) must have happened because the Reserve Bank has already started cutting interest rates?

Not quite. An RBA easing policy has not commenced.

At its February interest rates decision, where it lowered the cash rate from 4.35 per cent to 4.1 per cent, the central bank stressed that it was simply undoing or unwinding its December 2023 interest rate hike.

The bank concedes it doesn’t know whether demand in the economy is still greater than supply.

And it points to the relatively tight labour market as a possible signal there is too much demand.

To put it simply, there’s a level of unemployment which is, for want of a better phrase, inflation neutral.

The RBA is unsure if the current unemployment rate is inflation neutral or not, but it’s leaning towards not.

Its forecasts show “full employment” — which is another way of measuring this “non-accelerating inflation rate of unemployment” (NAIRU) — is 4.5 per cent.

But this week’s federal budget papers suggest it’s lower than that, at 4.25 per cent.

AMP says it’s even lower at 4.1 per cent, where it sits presently.

All about core inflation

But there’s one data point that we cannot escape: the March quarter ABS Consumer Price Index. This is what the Reserve Bank is waiting for.

If it shows core inflation is at the top of, or within its target band, the RBA will likely lower interest rates further.

So why does the bank need to wait for this data? Because its policy has shifted in recent years to lean heavily on data.

“Monetary policy changes can take time to affect the economy,” the RBA has noted.

“That is why the Reserve Bank has tended to look to what inflation is forecast to be in the future when deciding on the stance of monetary policy today.

“In recent years, however, the Reserve Bank has stated that it will focus more on actual inflation outcomes, rather than its forecasts for inflation, when deciding whether to adjust the cash rate.”

The obvious reason for this is to avoid being in a position where the bank cannot cover itself for a policy mistake.

In the event of a cutting cycle, for example, the RBA could point to a better-than-expected first quarter inflation outcome if it was criticised later for easing policy too early.

The RBA is still bruised after copping criticism when former governor Philip Lowe suggested, in the early years of the pandemic, that interest rates may not rise until 2024, followed reasonably quickly by one of the steepest tightening cycles in the bank’s history.

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Is cost-of-living relief urgent or not?

But is this fair when millions of households are still struggling to make ends meet?

This struggle is largely related to housing costs stress and paying for healthcare and insurance — which have little to do with “demand” in the economy. Mortgage stress is also hurting families.

Both major parties are also aware of households’ financial stress and desperation and are spruiking cost-of-living relief as the election campaign gets underway.

Labor is selling hip pocket help in the care arena, for energy bills, as well as in relation to personal income tax, while the Coalition is marketing its financial help for small business, motorists, and energy consumers in the longer term.

There’s another obvious source of financial relief for at least a third of Australian households — an RBA interest rate cut — but don’t hold your breath for that.

“Despite cutting the cash rate from 4.35 per cent to 4.1 per cent in February, the post-meeting commentary, comments in the Statement on Monetary Policy which updated the RBA’s forecasts and speeches from RBA officials sounded hawkish, implying that further rate cuts are not necessarily on the horizon,” AMP’s chief economist Shane Oliver wrote.

Meanwhile, ANZ Bank noted: “The first meeting of the new RBA Monetary Policy Board, which features two new members, should pass with no change to the cash rate.”

HSBC said: “We expect the RBA to be firmly on hold in April, but the global backdrop presents considerable risks to the outlook.”

RBC Capital Markets, however, is one of the few banks to reference the election campaign in its interest rates commentary.

The headline to its latest client note read: “PM calls an election for 3 May, another reason for the RBA to leave rates steady next week.”

Why would politics influence an RBA interest rates decision, especially when most economists agree the election outcome won’t influence the inflation trajectory?

The April dilemma

Herein lies the RBA April interest rate decision dilemma. Some analysts argue the bank has a strong case to cut the cash rate but is unlikely to do so in the middle of an election campaign.

The Reserve Bank also appears to be waiting for a data point — the March quarter CPI — that measures past price movements, despite lower inflation as well as other evidence pointing towards a weak economy which is unsustainably being supported by the public service.

And global economic threats persist, which economists argue point to further weakness in inflation.

A quarter of a percentage point cut to the cash rate would save a mortgage borrower on a variable $750,000 loan, assuming a 25-year term, roughly $100 per month.

Why is the Reserve Bank waiting for a single historical data point at the same time a federal election is being framed around the cost of living?

There isn’t any time to waste helping households stay afloat.