Australia’s annual inflation rate, as measured by the quarterly Consumer Price Index, fell to 2.4% in Q4 2024, the lowest since Q1 2021, down from 2.8% in Q3 2024 and below the market consensus of 2.5%. The drop in headline inflation was attributable mainly to large declines in electricity prices (-25.2%) and fuel prices (-7.9%). The categories experiencing the largest price increases were alcohol and tobacco (6.2%), health (4.0%), insurance and financial services (5.4%), and education (6.5%). The RBA’s trimmed mean CPI rose 3.2% year-on-year, the lowest reading in three years but still above the Bank’s official 2-3% target range. Labour market statistics are strong and consumer and business sentiment improving, but the outlook for the global economy is highly uncertain, as the geopolitical landscape keeps shifting. In light of falling inflation, the Shadow Board’s stance has shifted towards favouring a rate cut since the last round: it attaches a 52% probability that lowering the overnight rate by 25 bps to 4.10% is the optimal policy setting.
The seasonally adjusted unemployment rate fell to 4.0% in December 2024, on the back of an increase in total employment of over 56,000 and a steady labour force participation rate of 67.1%. The underemployment rate also dropped, to 6.0%, coinciding with an increase of monthly hours worked of 0.5% (November to December), to 1,976 million. Job advertisements rose by 0.2% in January, while job vacancies rose for the first time in nine months. Data on wages growth, as measured by the wage price index, will not be released until 19 February, one day after the RBA’s interest rate decision. It is expected to be around 3.5%.
Since the last round, the Australian dollar dipped below 62 US¢ but has since rebounded to above 63 US¢. The yield on Australian 10-year government bonds rose slightly, to 4.49% (14 February). This likely reflects markets’ assessment that inflation is not going to retreat quite as swiftly as projected a few months ago. The short-term yield curve (2y vs 1y) remains slightly inverted, with a spread of -6.9 bps, while the medium-term yield curve (5y vs 2y) is still considered flat, though with a higher interest spread of 13.5 bps. The long-term yield curve (10y vs 2y) shows “normal convexity,” with a widened spread of 63.0 bps. The Australian stock market, like the rest of the world, extended its bullish run, posting new all-time highs. (The S&P/ASX 200 Index closed at 8,556 on Friday, 14 February.)
Australian consumer confidence, according to the Westpac-Melbourne Institute Consumer Sentiment Index, softened slightly since the last round, falling from 94.6 points in November 2024 to 92.2 points, above the three-year average but below the neutral benchmark of 100. Retail sales, while soft in December 2024, increased 4.6% year-on-year, up from a revised 3.1% increase in November. Housing credit specifically, and private sector credit more generally, expanded by 0.5% and 0.6% month-on-month in December, respectively.
Australia’s business sentiment has continued to yo-yo, making it difficult for policymakers to read much into the numbers. The NAB Business Confidence Index jumped to 4 in January (up from -2 in December), the S&P Global Australia Manufacturing PMI climbed higher to a revised 50.2, compared to 47.8 in December, while the S&P Services PMI also rose, from 50.8 to 51.2, the strongest increase since August. The Westpac-Melbourne Institute Leading Economic Index remained flat in December; for 2025 Westpac projects Australian GDP to grow by 2.2%, noting however, that this depends on inflation and on the timing and magnitude of interest rate cuts. The Composite Leading Indicator increased marginally to 100.35 points in December, just above the long-run average of 100. Capacity utilization increased slightly in December, to 82.8%, corporate bankruptcies retreated from their all-time high in November.
The outlook for the global economy is dimmed by the prospect of an all-out trade war, following President Trump’s announcements of broad tariffs. It remains to be seen whether the latter can be sustainably averted, or whether the US will follow through with its threats. This also applies to Australia, which is due to face duties on the export of steel and aluminium, unless an exemption can be negotiated. Even if Australia is spared any direct tariffs, the slowdown in global trade is likely to adversely affect the Australian economy. The US economy is still performing strongly: employment continued to grow, the unemployment rate fell from 4.1% to 4%, hourly earnings in January increased by 4.1% year-on-year. The strength of the US labour market sparked a rise in US bond yields, reinforcing the Fed’s decision to slow the pace of monetary easing. Last week’s News Release by the Bureau of Labor Statistics revealed that the performance of the US economy was fuelled by strong productivity growth (2.3% in 2024), on the back of high business investment in labour-saving and labour-augmenting technologies. This should serve as a stark reminder of the importance of investment for those countries and regions, whose economies are flagging, including Australia.
The Shadow Board’s conviction of keeping the overnight rate, currently equal to 4.35%, on hold has weakened considerably and now favours a rate cut. The Board now attaches a 36% probability that this is the appropriate setting (down from 55% in previous round), a 12% probability (34%) that the overnight right should increase, to 4.6% or higher, and a 52% probability (11%) that the overnight right should decrease to 4.1% or lower.
The probabilities at longer horizons are as follows: 6 months out, the confidence that the cash rate should remain at the current setting of 4.35% equals 20% (previously 28%); the probability attached to the appropriateness of an interest rate decrease equals 64% (36%), while the probability attached to a required increase equals an unchanged 16% (36%).
One year out, the Board’s lean towards monetary easing has also strengthened noticeably: members’ confidence that the appropriate cash rate should remain at the current level of 4.35%, equals 12% (21%), while the confidence in a required cash rate decrease, to below 4.35%, equals 72% (62%), and its confidence in a required cash rate increase, to above 4.35%, is 16% (18%). Three years out, the Shadow Board attaches an 13% probability that 4.35% is the appropriate setting for the overnight rate (previously 14%), a 77% probability that a lower overnight rate is optimal (78%) and a 10% probability that a rate higher than 4.35% is optimal (8%).
The range of the probability distribution for the current interest rate recommendation has narrowed to 3.85% to 4.85% (from 3.85% to 5.35%). At longer horizons the ranges have widened slightly, or remain unchanged, as follows: they extend from 3.10% to 5.10% for the 6-month horizon, from 2.35% to 5.60% for the 12-month horizon, and from 0.85%-5.35% for the 3-year horizon.
Until a few months ago I thought the RBA should raise rates. But inflation is falling faster than expected, even when allowing for the temporary effect of fiscal subsidies. There is now a discernable possibility of inflation falling below the target. And unemployment is likely to rise. So a cut seems sensible.
