Market Musings: RBA rate relief & the AUD
Favourable trends in Australian inflation mean interest rate relief for indebted households and businesses is on the horizon. Q4 2024 CPI printed below consensus forecasts (as it has tended to do over the past two years), and importantly it also undershot the RBA’s projections. Headline inflation rose just 0.2% in Q4 with the annual rate running at 2.4%pa. The trimmed mean (i.e. the RBA’s preferred underlying metric that provides a guide to inflation persistence) came in at 0.5%qoq. As a result, core inflation decelerated to 3.2%pa, with 6-month annualised growth, a gauge of the pulse rate trajectory, stepping down to ~2.6% (chart 1). This is close to the middle of the RBA’s target and the slowest core CPI has been on this measure since Q3 2021.
At its December 2024 meeting the RBA had opened the door to a change in H1 2025 after it jettisoned ‘hawkish’ rhetoric and noted it was gaining “some” confidence inflation was moving in the right direction. In our opinion, the Q4 2024 CPI should bolster its belief that inflation is heading back to target on a sustainable basis. As such, we feel the RBA will announce a 25bp interest rate cut when it meets on 18 February. We had long thought that the start of the RBA’s easing cycle would be in H1 with every meeting ‘live’ for a move and the jumping off point driven by the flow of data.
That said, although we think the beginning of an RBA policy easing cycle is imminent, we remain of the view that this will be more akin to a 'recalibration' in policy settings to match the slowdown in inflation rather than the start of a sharp adjustment in interest rates. In our judgement, the stickiness in prices across services and discretionary categories (chart 2) on the back of the resilience in the Australian jobs market, still high level of activity across labour-intensive sectors, and robust growth in public demand means that this RBA easing cycle should be limited and drawn out.
On the provisos Australian inflation continues to moderate and the labour market doesn’t deteriorate sharply we believe quarterly steps down towards ‘neutral’ (i.e. ~3.35%) over the next year is the most likely course ahead for the RBA. This is similar to what has been unfolding in other nations such as the US and UK where consumer price pressures have moderated from their COVID era peaks but economic activity and/or the jobs market is holding up which is creating lingering inflation challenges (charts 3 and 4).
The AUD (now ~$0.6235) lost a little ground in the wake of today's Q4 CPI as the odds of a February RBA rate reduction is more fully discounted. A 25bp move is now ~96% factored in. While the first step has been brought forward the outlook for the RBA’s cycle hasn’t materially changed. Interest rate markets are pricing in just over three cuts in 2025. All up, we continue to think that the RBA will lag several of its global peers in terms of how much interest rate relief is delivered, just as it proactively did during the tightening phase as it looked to cushion the potential negative impacts on the labour market. Although, based on the higher share of variable mortgage rate debt held in Australia, even more limited RBA’s moves on the way down could be more growth supportive than elsewhere.
Hence, with the AUD trading at a discount to fundamentals (it is tracking ~4 cents below our ‘fair value’ models (chart 5)), an underlying bearishness embedded (‘net short’ AUD positioning, as measured by CFTC futures, is elevated), and it not sustainably trading much below where it is in recent times (the AUD has only been sub-$0.62 ~1% of the time since 2015 (chart 6)) we believe further near-term downside should be limited. At the same time however, with US trade tariff risks still lurking and the USD firm, any near-term AUD rebounds are also likely to be capped. As per our 2025 outlook we see the AUD oscillating in the low- to mid-$0.60s over coming months as domestic and offshore cross-currents play out.
Peter Dragicevich
Currency Strategist - APAC
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