Australian inflation accelerated to its highest rate in six months in May, as annual headline CPI jumped to 4.0% from 3.6% in April.
The outcome was stronger than market expectations of a pickup to 3.8%. Trimmed mean inflation also accelerated to 4.4% from 4.1% in May.
While the monthly CPI series is volatile, the figures reinforce the persistence of Australia’s inflation problem with headline inflation running at its fastest rate since November 2023. Worryingly for the RBA, underlying inflation across various measures has failed to decline further in 2024, remaining ‘stuck’ above 4.0%.
Digging into the Details
The most significant contributions were Housing (+5.2%), Food and non-alcoholic beverages (+3.3%), Transport (+4.9%) and Alcohol and tobacco (+6.7%). Meanwhile, goods held at 3.3% year-on-year, but services jumped to 4.8%.
The annual rise in new dwelling prices remained steady at 4.9% in May, maintaining a consistent annual growth of around 5% for the past ten months. This reflects builders continuing to pass on higher costs for labour and materials. Rental prices increased 7.4% in the 12 months to May, down from 7.5% in April, reflecting a combination of strong demand for rental properties and tight rental markets which has continued to drive rental price rises.
Consumers were also hit with the biggest annual rise in fruit and vegetable costs in a year, while inflation in the cost of alcohol, clothes and electricity also increased in annual terms.
Electricity prices rose 6.5% in the 12 months to May, up from a rise of 4.2% to April. The increase in the annual movement this month was driven by the gradual unwinding of the Energy Bill Relief Fund rebates which artificially lowered prices in the prior corresponding period.
Subsidies to Lower Headline CPI in Q3
Upcoming government subsidies coming into effect from July, which include a $300 electricity subsidy from the Federal Government and a $1,000 rebate for Queenslanders, will cause electricity prices to decline 20% in the September quarter, subtracting 0.5% from CPI.
While that could be enough to temporarily send headline inflation below 3.0%, underlying inflation (excluding these temporary measures) would still remain well above the RBA’s 2.0 – 3.0% band. The Federal Government's attempts to ease headline inflation, via cost of living subsidies, is unlikely to influence the RBA which will focus on underlying measures of inflation. RBA Governor Michele Bullock has already stated the board will look through the disinflationary effect of the subsidies since they were temporary.
Of course, the counter argument is that these subsidies, alongside the July tax cuts, will add additional inflationary pressures as they increase aggregate demand. While this should support the economy in the second half of the year, we doubt it will significantly stoke inflation given the weak economic starting point and likely propensity of households to save a good portion of this fiscal assistance.
August RBA Meeting – We’ve Got a Live One!
While the RBA still considers the quarterly CPI to be the best gauge of inflationary pressures, recent monthly releases have garnered increased attention from the market, leading to sharp moves in interest rate expectations.
Interest rate markets were quick to price in a “live” August 6th RBA meeting, shifting the probability of a hike to 40%, up from 12% prior to the release. The probability of a September hike now sits above 50%.
The most important measure of inflation for the RBA is the Trimmed Mean CPI, which worryingly spiked again to 4.4%, the fastest pace since November 2023, suggesting inflation is running ahead of the RBA’s forecast for underlying inflation to ease to 3.8% in the June quarter.
The higher-than-expected May CPI is the first of two inflation prints before the next RBA meeting. If inflation annualises above the current 4.0% the RBA’s next move will likely be a hike. The June quarter CPI figures due July 31st will be decisive.
We see the August meeting as a ‘close call’ and shift our view to a higher for longer cash rate peak through 2025, with the timing for the first rate cut pushed back from the first half of 2025 to the second half of 2025.
A Tricky Balancing Act for the RBA
The combination of well above average inflation, well below trend economic growth, but a tight labour market leaves the RBA in a difficult position.
The RBA will be well attuned to the weakening in the economy when thinking about policy. Softer than expected first quarter real GDP, weak retail sales and broader weakness in consumption cautions against additional RBA rate hikes despite sticky inflation. The ongoing weakness in economic activity is consistent with monetary policy being in 'restrictive' territory, causing consumer demand to weaken and unemployment to lift with a lag. In our view this reduces the urgency to hike rates.
RBA Governor Bullock gave a hawkish press conference after the RBA's June meeting, which indicated the Board considered a rate hike again. The messaging was similar to that ahead of the last hike in November 2023, with the Governor ‘setting up’ for a potential rate hike in August, particularly if CPI surprised to the upside.
We think it would take a material upside surprise of over 1.0% quarter-on-quarter, especially for the trimmed mean, to trigger a hike, as it would indicate that the prior trend of slowing inflation has ended, and it would also show a re-acceleration of inflation momentum. Albeit, to actually hike the RBA may also need the labour market data to remain resilient, the June employment report due July 18th will also be closely watched.
Goodbye to 2025 Cuts?
The market’s pushback to the timing for the first fully priced RBA cut to 2026, is too hawkish in our view. Sluggish economic growth and (eventually) a moderate rise in the unemployment rate should bring inflation down toward the target band over the course of next year. The RBA should be able to ease policy in the second half of next year, although, we pare back our expectations from 3-4 rate cuts to 1-2 by the end of 2025.
This is a significant lag compared to other central banks, but Australia will ultimately join the global easing cycle next year, albeit, somewhat belatedly. Which, should all things equal, support the Australian dollar but will present medium term headwinds at the margin for our equity market.
A less favourable domestic monetary policy outlook saw us trim Australian equities to a slight underweight in our Third Quarter Asset Allocation Outlook.
The stronger than expected May inflation data and subsequent material lift to the interest rate path towards higher for longer rates, further reinforce our view.
Domestic floating rate credit continues to appeal given the relatively benign macro environment but higher for longer cash rate environment. This CPI result and the resultant shift in cash rate expectations will keep some upward pressure on bond yields particularly the front end of the curve.
Written by
David Cassidy, Head of Investment Strategy
David is one of Australia’s leading investment strategists.
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