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Inflation is low and remains low

Inflation edged up a little in the March quarter – from an annual rate of 1.5 per cent at the end of 2016, the headline rate rose to 2.1 per cent. The underlying rate of inflation, which the RBA trends to place more weight on when it comes to assessments of interest rate policy, was even more muted, lifting from 1.5 per cent to 1.8 per cent.

And recall, the RBA target range for inflation is between 2 and 3 per cent.

Annual underlying inflation has been at or below 2 per cent since late 2015, and has been below 2.5 per cent, the midpoint of the inflation target, since the end of 2014. That is a long time.

The data today confirm that inflation is low and remains low and in isolation, continues to give the RBA plenty of scope to further reduce interest rates. When the recent data on unemployment, building approvals, private sector business investment and wages growth are added to the mix, the case for an interest rate cut is strong.

“Strong”, that is, except for two items – the boom in house prices in Sydney and Melbourne is a thorn in the side of the RBA, and signs that the global economy is performing well is good news because it should provide a boost to the Australian economy if it is sustained for the next year or more.

Importantly, the inflation outlook remains skewed firmly to the low side. Even the RBA is forecasting inflation to stay around 2 per cent right through to the end of 2018 which if correct, means its interest rate policy bias is towards cutting interest rates especially if, or rather when, the heat in Sydney and Melbourne house prices starts to fade.

On that score, there is plenty to suggest housing is about to weaken. The extension of regulatory changes to lenders will crimp demand, particularly from investors. The pending supply deluge will also work to dampen prices, especially in the second half of 2017 and into 2018. Add to that, some bank-initiated hikes in mortgage interest rates and the stars are aligning for the housing market to hit the wall, at least in terms of price changes.

Already there are some signs of a cooling in housing. While there is a seasonal pattern to house prices, the recent Corelogic series points to prices edging lower in Sydney and topping out in Melbourne. Weakness over the next few months, while welcome, could be problematic if it goes too far or builds momentum.

Globally, inflation is well contained. This is important for the Australian economy which is closely linked to global economic trends. There was a clear lift in price pressures late 2016 and early 2017 largely on the back of the rising price of oil and other commodities but these have clearly reversed in the most recent data.

All of which suggests that Australia’s next inflation reading will be lower and with that, the pressure will remain on the RBA to cut interest rates. If this coincides with clear evidence of a weakening in house prices, the next interest rate cut could be delivered in August or September.