Australia’s inflation rate is on the cusp of falling to levels rarely, if ever, seen over the last 50 years as the mix of weak domestic growth, record low wages increases, global economic dislocation and collapsing national income all bite.
The ever-reliable TD-MI monthly inflation gauge confirmed that consumer prices were flat in December which saw the through the year increase plummet to 1.5 per cent. More extraordinary is the loss of inflation momentum. In the past 7 months, inflation has been just 0.4 per cent, which annualises to 0.7 per cent. This is extraordinarily low, even if a few tenths of weakness is due to the fall in petrol prices. It is also extraordinary given the 25 per cent fall in the Australian dollar which clearly is not being passed on to consumers due to moribund demand and dreadfully low wage gains.
The RBA fell asleep during 2014 – failing to hike rates early in the year to nip the house price surge in the bud, then failing to go hard on macroprudential issues for bank lending and then failing to cut rates near year end as the terms of trade went into free-fall and the unemployment rate rose.
But all is not lost.
When the official CPI for the December quarter is released next week, the low headline and underlying inflation rates will allow the RBA to tell the media and market economists of its change of heart so it can deliver a 25 basis point rate cut at its February meeting without huge surprise.
From the RBA’s perspective, the risks of stoking upside inflation pressures from an interest rate cut are not only misguided, but if inflation lifts, it would be desirable. I suspect a 2.25 per cent cash rate in the current environment is not enough to see the economy move back towards trend or inflation to rise, so it will need to cut the cash rate towards 1.5 per cent during the year to help underpin growth and reflate the economy.
Inflation is too low and it is falling. The unemployment rate has been at or above 6 per cent for the best part of a year. Wages growth is at lows never before seen in Australia’s history. The terms of trade are in free fall. Real GDP remains below trend with no obvious signs of picking up.
Australian interest rates are among the highest in the industrialised world. The Australian dollar is too high. Rates shouldn’t be this high and when this simple points sinks in at the RBA, it will cut, cut, cut.