The case for Australian interest rates to come down faster than people are expecting

Australian interest rates influenced by US inflation trend

On 13 June, US consumer prices (CPI) came in lower than expected for the month of May. The market was expecting 3.4% inflation in May, where the actual number came in at 3.3%. It might not seem like a big difference, but we believe it is significant enough for the market to become more bullish on future rate cuts in the US…and Australia for that matter.

 

Core inflation was even lower than expected

Core inflation, which excludes food and energy costs, actually came down more than expected and dropped to 3.4% in May, where the market was expecting 3.6%. Core inflation is one of the FED’s key yardsticks in its policy making. And Services inflation, which has been the most sticky so far, dropped across the board.

 

The market is now more bullish than the FED

Following these May CPI numbers, the FED signalled one rate cut is in the cards for 2024 and four rate cuts for 2025. This is one more cut in 2025 than previously flagged. However, the market is now pricing in two rate cuts in 2024 already, given that it sees inflation coming down at a good pace.

As a results, the US share market was up … all indices closed higher overnight, with some even touching new all-time-highs before coming down a little before the close.

 

Australian inflation is headed in the same direction

Australian inflation in the March quarter came in at 3.6%, i.e. below the 4.1% recorded in the December 2023 quarter. And we expect inflation to keep trending down during the rest of 2024 and in 2025 as the current cost-of-living crisis is leading consumers to reduce their discretionary spending. In our view, this creates space for the RBA to lower interest rates, probably sooner than most pundits are currently predicting. And not just because of inflation coming down.

 

2025 is an election year and the RBA is not independent

Given that 2025 is an election year, we believe we will see the current Labor government start to lean more and more on the RBA to lower the cash rate in time for some financial reprieve for consumers in the run up to these elections.

Additionally, the RBA has two policy targets: price stability, i.e. keeping inflation between 2% and 3%, and full employment. But it only has one instrument: the cash rate. And as economic Nobel Prize Laureate Jan Tinbergen showed a long time ago, a Central Bank can’t have two target and only one instrument. In other words, it will need to start favouring one over the other if a conflict arises, which there very well could.

 

Economic headwind will force the RBA’s hand

Australian unemployment is on the rise. It rose from 3.9% in March 2024 to 4.1% in April. And GDP growth continues to slow…6 quarters in a row now, to just 0.1% quarterly growth in the March 2024 quarter. We might actually see a technical recession in Australia in the near future, never mind the per capita recession that we have been in for the last 15 months!

In such a weakening economic environment, we don’t expect to see the RBA stubbornly holding the cash rate at the current 4.35% for very long. Consumers are suffering and the economy is slowing down…not great with elections coming up and it is not in line with the RBA’s targets.

 

The Aussie dollar is also getting stronger

What won’t help either is that the Australian dollar is strengthening, making the country more expensive when it comes to exports, such as commodities, education and tourism. Merely to fact that US inflation came in lower than expected overnight, led to a jump in the Australian dollar versus the US dollar.

Interest rates are starting to come down around the globe and if the RBA does nothing, the strengthening dollar will contribute to economic weakening.

 

Conclusion: The pressure is getting too strong for the RBA to ignore

We believe that the global inflation trend is down. Given that the forces at work, including overseas inflation and interest rates, domestic economic weakness and the fact that 2025 is an election year in Australia, we expect the RBA will make a downward move in the Australian interest rates (cash rate) sooner than most people are projecting, probably late in 2024.

 

Get ready for the Small & Mid Cap Technology and Life Sciences revival

Falling Australian interest rates is good news for stock investors as valuations would likely see a broad rerating in that situation. We especially like interest rate sensitive Small & mid Cap Technology and Life Sciences stocks in such an environment. They have been hit the hardest in the last two years. So, put some of them on your watch list!

 

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