Australia Q4 inflation hits two-year low, fuelling expectations for rate cuts

Australian inflation in the fourth quarter of last year decelerated more sharply than anticipated, marking a two-year low. This slowdown, particularly evident in core inflation, has heightened expectations of impending rate cuts among investors.

The Reserve Bank of Australia (RBA) is likely to find solace in the latest inflation figures as it prepares for its inaugural policy decision of the year, scheduled for next Tuesday. 

Market sentiment has decidedly shifted away from expectations of further tightening, with forecasts now leaning towards potential rate reductions.

Following the release of data from the Australian Bureau of Statistics, which revealed a 0.6 per cent increase in the consumer price index (CPI) for the fourth quarter, the Australian dollar dipped 0.4 per cent to $0.6575. 

Concurrently, three-year bond futures climbed to 96.40, reaching their highest level in two weeks.

While the CPI rose by 3.4 per cent year-on-year in December, a noticeable decline from November's 4.3 per cent, Barclays has adjusted its projections, anticipating the RBA's first rate cut to materialise in the third quarter, a shift from the previous forecast of the fourth quarter.

Treasurer Jim Chalmers acknowledged the deceleration in inflation but cautioned against premature celebration, stressing that the task is far from complete.

Since May 2022, the RBA has implemented interest rate hikes totaling 425 basis points, aiming to rein in surging prices. Despite maintaining a cautious approach, the RBA remains committed to its annual inflation target of 2-3 per cent.

While domestic economic indicators largely align with the RBA's expectations, international developments have been more tumultuous. 

As inflation rates plummet abroad, markets anticipate forthcoming interest rate cuts from both the Federal Reserve and the European Central Bank, with predictions pointing to May for the Fed and April for the ECB.

The latest report highlights progress in curbing both goods and services disinflation. Although services inflation exhibited a slight easing trend for the second consecutive quarter, non-tradeable goods and services inflation, influenced primarily by domestic demand, remained elevated at 5.4 per cent.\

Looking ahead, economists foresee a gradual decline in inflation, albeit at a decelerated pace. 

However, potential challenges lie ahead, particularly with the impending implementation of stage three tax cuts, which coincide with the RBA's efforts to withdraw liquidity from the economy. 

Moody's Analytics projects a potential RBA rate cut in September, citing this convergence of fiscal and monetary policies as a complicating factor.

(With Reuters Inputs)