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Uncertainty in the world provides certainty for May rate cut
As Australians head to vote in the Federal election this weekend, data showed underlying inflation had finally slowed to within the RBA's target band in the March quarter for the first time in three years - since Australians last headed to vote in a Federal election.
Headline CPI rose by 0.9% in the March quarter with the annual rate remaining steady at 2.4%. Services inflation slowed over the quarter, but remains elevated at 3.7%, driven by education (+5.7% y/y), health (+4.1% y/y) and insurance (+7.6% y/y). Goods price inflation has been more subdued, due to downward pressure on fuel and electricity, though both categories recorded increases in the March quarter. The cost of housing remains elevated, but rental growth is showing a clear downward trend and the prices of new project homes are being discounted to stimulate demand in a subdued new-home market.
Trimmed mean CPI, the RBA's preferred measure of underlying inflation, rose by 0.7% in the March quarter, in line with QIC forecasts, with the annual rate of underlying inflation slowing to 2.9%. Slower underlying inflation has provided hope amongst stretched mortgage holders that the RBA will soon release the economic brakes by cutting the cash rate further.
So, does the March quarter CPI pave the way for a May rate cut?
The RBA is widely expected to deliver a 25bp rate cut at their 19-20 May meeting, but this has little to do with this week’s inflation numbers. In reality, the RBA was already very likely to cut rates in May given the turmoil created by Trump's reciprocal tariffs over April, which resulted in widespread downgrades to the prospects for the US and global economies since the RBA last met. For example, the IMF downgraded its outlook for US and global growth over 2025 by almost a full percentage point between January and April. Further downgrades are likely after data this week showed the US economy contracted in the first quarter of the year as businesses imported more goods to front-run price rises associated with increasing tariffs. The fall in US GDP in the first quarter, combined with chaotic trade policy weighing on spending decisions in the second quarter, raises the prospect of the US economy already being in recession. Our view is that the US should narrowly avoid a technical recession, but that growth will stall over 2025.
While the final tariff outcome remains far from clear, we expect Australia to benefit from lower foreign prices of manufactured goods that will be redirected away from the US. We estimate that downward pressure on consumer prices of clothing and footwear, household appliances and furnishings, electrical equipment, leisure goods and motor vehicles, all of which have a high import component from China/East Asia, could reduce inflation in Australia by around 0.1 percentage point per quarter for the remainder of this year.
The deterioration in the global outlook over the last month has also impacted commodity markets. In particular, the price of oil has fallen from over $US70/bbl at the end of March to below $US60/bbl currently.
Typically, the $A would weaken in an environment of deteriorating global growth, and this was the case in the immediate aftermath of the reciprocal tariff announcement. But the $A has subsequently recovered as the US$ weakened. The $A oil price is a good indicator of fuel prices in Australia, and it has fallen by 16% since the end of March. While it may not be maintained at this level, lower fuel prices will likely supress the June quarter CPI.
Lower prices for manufactured imports and fuel have led us to downgrade the inflation outlook over the remainder of the year. Headline inflation is now expected to fall briefly below 2% in the June quarter, before rising back to around 3% as State and Federal government electricity rebates expire in the December quarter. Importantly, underlying inflation is expected to move into the bottom half of the RBA's target band in the second half of this year and remain below the midpoint in 2026.
With inflation moving comfortably lower, there is room for monetary policy to shift from being restrictive to modestly stimulative. We expect the RBA to deliver three more 25bps rate cuts, which would take the cash rate to 3.35%, a rate that we see as below the neutral level. Markets are currently expecting around 125bps of rate cuts over the coming year, taking the cash rate to 2.85%. Our view is that this magnitude of monetary easing would likely be associated with heightened risks of recession, which is not our central case for Australia. We remain of the view that, while the global trade disruptions will weigh on the outlook for Australia, economic growth is in a gradual recovery phase underpinned by improving real disposable incomes and still-solid government spending, regardless of who wins this weekend’s Federal election.