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Rate cut looms large as prices barely budge

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Chris Zappone

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Shock inflation figure signals multiple rate cuts

Financial markets think a rate cut is certain next Tuesday, and are already factoring in multiple interest rate cuts following a dramatic fall in inflation.

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An official rate cut next week seems all but a certainty after official inflation data showed prices barely budged in the March quarter.

Consumer prices inched up a less than expected 0.1 per cent in the first quarter, following a flat reading in the previous three months.

We think the May rate cut is pretty much done and dusted now. 

For the year to March 2012, prices increased by 1.6 per cent, following a 3.1 per cent increase over 2011, the Australian Bureau of Statistics said today. The market had expected a 0.6 per cent rise in the quarter and a 2.2 per cent rise in the year.

The core inflation measure, which is watched closely by the Reserve Bank in setting policy, was 2.15 per cent in the year to March, down from 2.6 per cent. For the March quarter it was 0.35 per cent, down from 0.5 per cent.

Betting on a June cut

The dollar fell from $US1.031 to $US1.026 immediately after the data was released, as markets bet on more than one official rate cut.

Investors are now pricing in a 100 per cent chance of a 25 basis point cut in May, and a one-in-four chance of a 50 basis point cut. Before the inflation update, the market was tipping only a 93 per cent chance of a rate reduction next month.

And with inflation seemingly contained for some time to come, investors were willing to lend the government money for 10 years at just 3.67 per cent. That is the lowest 10-year bond yield since the early 1950s.

‘‘We think the May rate cut is pretty much done and dusted now,’’ said RBC Capital Market economist Michael Turner. ‘‘Next month is almost a given and the question is whether the RBA follows up with another cut in June.’’

The low inflation reading meant the RBA could even afford to cut rates by more than 25 basis points, Rochford Capital director Thomas Averill said, adding that such a move would be unlikely.

‘‘Certainly this has given the RBA the scope to cut by 25 basis points at the next meeting,’’ he said. ‘‘I think the RBA has been slow to react to the lower pace of domestic economic growth and a clear downward trend in inflation.’’

Tweeting for a big cut

Treasurer Wayne Swan welcomed today's inflation figures. "In particular, underlying inflation remains contained," he told reporters in Canberra.

"Contained inflation is a reminder of our strong economic fundamentals that put the Australian economy is a league of its own," he said, adding that it created room for rate cuts.

But Mr Swan acknowledged that many households were still doing it "tough".

"We can see this in the figures," he said. "There are a number of seasonal factors effecting in particular, health and education."

Shadow Treasurer Joe Hockey said that the CPI figures indicated that overall inflationary pressures are benign but that much of it is due to a decline in fruit prices as growing conditions recover following last year's natural disasters.

In a statement, Mr Hockey said the figures confirmed the cost of key household items continues to "outstrip average incomes" and that the carbon tax "will further intensify these cost of living pressures".

"If Labor cared about cost of living pressures they would immediately abandon their plans to introduce this destructive new tax which will increase the price of everything," he said.

Mr Hockey's comments came as Opposition Leader Tony Abbott tripped up over the Reserve Bank board meeting, which is scheduled for next Tuesday.

This morning, Mr Abbott incorrectly referred to the RBA board meeting occurring today.

"Should the Reserve Bank lower interest rates today that will be welcomed," he said.

Mr Swan said that if Mr Abbott was more focussed on the economy and less on his "mud bucket", then he would know when the RBA board was next meeting.

Fruit prices plunge

Key to containing inflation has been the strength of the Australian dollar in the first quarter which reached peaks not seen since 1985 when measured in trade weighted terms.

That in turn pushed down prices for a whole range of imported goods, from cars to computers, clothes and industrial machinery. Figures out last week showed prices for imported consumer goods fell 2.7 per cent in the first quarter, taking that index to lows last seen two decades ago.

Inflation was also pulled down by a 30 per cent drop in fruit prices in the quarter and a 5 per cent drop in international holiday costs, most likely aided by the strong Australian dollar.

Coles today reported a record 25 per cent price fall in fresh fruit and vegetables in the first three months of the year.

Electronics prices fell 6.3 per cent in the quarter while domestic travel fell 2 per cent, the ABS said.

On the other end of the scale, drug prices rose 14.1 per cent in the quarter, while tuition costs for secondary education increased 7.7 per cent.

RBA focusing on prices

The Reserve Bank said earlier this month that a weaker first quarter inflation reading would allow it cut the interest rate on May 1 if needed.

In its April 3 meeting, the RBA said: ‘‘The board judged the pace of output growth to be somewhat lower than earlier estimated, but also thought it prudent to see forthcoming key data on prices to reassess its outlook for inflation, before considering a further step to ease monetary policy.’’

The gap between the mining and non-mining economy has grown over the past year, as the commodities boom rewards areas associated with mining, while driving up costs nationwide.

Inflation not gone

HSBC economist Paul Bloxham said that inflation was notoriously difficult to forecast, which accounted in part for the surprise in the number today.

"We expect the Reserve Bank to cut the interest rate by 25 basis points next week," he said, but dismissed calls for a 50 basis point cut.

He also downplayed the likelihood of the RBA cutting a total of 50 basis points from the cash rate in coming months.

"The parts of inflation that are very persistent that tend to be steady were actually steady at reasonably high rates [in the March quarter]," he said, adding that included items like utilities and tuition.

The fall in inflation was triggered by dropping food prices and the appreciation of the exchange rate, he said.

"It's highly likely those things won't continue and that at some point down the track inflation will drift up again."

With Judith Ireland

85 comments

  • Doesn’t matter because the banks have a higher borrowing cost allegedly so it seems a reduction in base rate only means a reduction in saving account interest these days and no change to your mortgage.
    Still like to know why in the UK you can get a 3% mortgage considering all the banks borrow from the same international market and the UK has to borrow in a foreign currency as well!

    Commenter
    dwaindibbley
    Location
    Melbourne
    Date and time
    April 24, 2012, 12:20PM
    • Very true, savers will get squashed again but the banks tread a fine line. If interest payments drop too much i will be inclined to remove large sums of cash into other assets, likely gold. Less local deposits also mean banks have less to lend and may restrict credit. No one mentioned yesterday in the gold article that as the aussie dollar falls, gold wins. Also there are over 1 billion in india alone that love the product and put it to use (jewellery).

      Commenter
      credit squeeze
      Location
      Melbourne
      Date and time
      April 24, 2012, 12:48PM
    • If you want to borrow in pounds, you too could probably get a 3% mortgage. If, however you want $A, the currency hedging and transaction costs mean you will pay about 6%

      Commenter
      scrub
      Date and time
      April 24, 2012, 12:50PM
    • The recent rate increases by the big 4 were pre-emptive moves to give them room to reduce rates following this impending rate cut. Even if there is no rate reduction by the big 4, an interest rate cut will still mean a fall in the exchange rate - effectively reducing the windfall for mining companies and thus help stimulate the non-mining side of the economy including exporters. The aussie dollar has been overvalued for some time and really should be at the 85c mark - good for mining and non-mining companies jointly.

      Commenter
      Danny
      Location
      Wollongong
      Date and time
      April 24, 2012, 12:51PM
    • That's right - again savers get shafted and the over-leveraged get a pat on the back. Interest rates should be increased each and every month until housing reaches fair value (~50% of current bubble prices) and then left alone.

      Commenter
      Andy!
      Location
      Melbourne
      Date and time
      April 24, 2012, 1:07PM
    • danny a reduced exchange rate is great for miners as most of their sales are in us dollars

      Commenter
      brinkin
      Date and time
      April 24, 2012, 1:45PM
    • CPI decrease ?

      Could have fooled me. What smoke and mirrors method did they use to work this out ?

      Power down ? Petrol down ? Insurance down ? Public Transport down ?..........................

      Commenter
      Fundies
      Location
      Sydney
      Date and time
      April 24, 2012, 1:46PM
    • It is blatantly clear that RBA has managed to destroy economy for the third time since 1987 by keeping interest rates much higher than economy can sustain.

      We are going to see the repeat of the 2008 - chain of deep panic cuts eventually bringing rate to 0%.

      And because we had to have rates in this level for at least couple of years already - economy wold not be able to get back on track just by cutting rates. We will need tens of billions in stimulus.

      Commenter
      Michael
      Location
      Sydney
      Date and time
      April 24, 2012, 1:48PM
    • @Scrub, the difference is it is a lot harder to get a loan in the UK. Rates are lower there because banks are trying hard to get their money back.

      Over here, you can still walk into a bank with a semi-reasonable deposit and borrow a gazzillion dollars.

      It's not the interest rates that are hurting Australians. It is the size of their mortgages.

      Commenter
      HB Fair
      Date and time
      April 24, 2012, 1:52PM
    • So Andy I take it you want to see a lot of home owners lose large amounts of money so you or people you know can afford a house? There goes that old sense of entitlement again.

      Commenter
      Ranger
      Date and time
      April 24, 2012, 2:10PM

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