Vital clue Australia is headed for an interest rate cut - not the hike a few noisy economists claim

A few noisy economists are worried about inflation being higher for longer and possibly reaccelerating to the point that will force the Reserve Bank of Australia (RBA) to lift interest rates in the months ahead. Some are suggesting the 4.35 per cent cash rate needs to be at 5 per cent or more to get inflation lower.

This is despite the fact inflation has fallen, as the RBA has anticipated, over the past year. Or that a deep and extended slowdown in the economy, which started in the middle of 2023, will see a rise in unemployment and contain any upside wage pressures (and, yes, lower inflation ahead).

Thankfully the RBA does not share this scorched earth view, evidenced by its decisions to keep interest rates steady over the past six months, including at its May Board meeting.

The RBA forecast focused on inflation returning to reach the 2 to 3 per cent target in a reasonable time without further interest rate rises.

In its Statement of Monetary Policy, it is forecasting annual inflation to pick up to around 3.8 per cent over the remainder of 2024 before falling back to the target in 2025 and 2026.

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RBA Governor Michele Bullock, who warned hopeful mortgage holders she hadn't assured an interest rate cut in 2024, noted the sharp rise in petrol prices accounted for this upturn, with the measures for underlying inflation forecast to be significantly below the headline measures.

Interestingly, since that forecast was compiled, the global oil price has fallen by around 3 per cent, which if sustained, presents a downside to the forecast for headline inflation.

Australia's inflation fortune teller: Look into the crystal ball

What was not covered in detail in the RBA governor’s press conference was the inflation performance globally.

It has been a critical issue behind the trends for inflation in Australia and will be an important factor over the short to medium term.

On that score, it is generally good news on global inflation. The trend is lower with other major central banks set to reach their targets in the next 3 to 12 months.

In recent weeks, there has been a disjunction in the analysis of the inflation rate in Australia and around the world.

As noted, it prompted some forecasters to talk of interest rate hikes in Australia – while in the Eurozone, the US, Canada, the UK and New Zealand, the deceleration in inflation has money markets pricing in the start of an interest rate cutting cycle from around the middle of 2024 and over the remainder of the year and into 2025.

The table below shows how inflation has moved in the last two years in key global markets, including Australia.

Inflation rate – annual percentage change

Source: Trading Economics, National Sources

It is clear that from the extreme highs recorded during 2022, inflation was in free-fall during 2023.

The latest data, which includes inflation updates for the early months of 2024, shows a further moderation in inflation in most countries although it remains marginally above central bank targets and the pace of decline has been less than during 2023.

While the RBA was correct to point to an array of domestic economic news and conditions that will be important in the future path for Australian interest rates, what happens to global inflation will be vital to the timing and extent of interest rate moves.

Just as Australia was a major participant in the upswing in inflation in 2021 and 2022, it was part of the downside in inflation since those peak levels.

If inflation continues to track lower globally, that will assist the RBA with its inflation goals.

Interestingly, if the money markets overseas are correct to be pricing in a strong probability of interest rate cuts around the bulk of the world, Australia will likely be a part of that and it will cut too.

In the next few months, while all eyes will be on local Australian economic news, don’t forget to look at inflation overseas for any leading indicator for the RBA to follow.

It is interesting that Switzerland and Sweden have recently cut interest rates – the list will grow in the months ahead.

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