Disinflation is here: How will this affect interest rates?

Australia’s central bank has increased the cash rate exponentially over the past year but diminishing inflation figures may prompt the Reserve Bank of Australia (RBA) to pause its protracted cash rate hiking cycle. 

The Australian Bureau of Statistics (ABS) monthly Consumer Price Index (CPI) indicator rose 6.8% in the twelve months to February. This represents a 0.6% month-on-month decrease in annual inflation from January, when the statistics reported a 7.4% rise in annual inflation. The new monthly reporting series determined that annual inflation had peaked at 8.4% in December 2022.

The most significant contributors to February's inflation figures were increased costs in the areas of housing (+9.9%), food and non-alcoholic beverages (+8.0%), transport (+5.6%) and recreation and culture (+6.4%).

“This marks the second consecutive month of lower annual inflation, also known as ‘disinflation’, from the peak of 8.4 per cent in December 2022,” ABS head of price statistics Michelle Marquardt said.

Disinflation typically describes a slowing in the rate of inflation over the short-term. Proponents argue that a healthy amount of disinflation over time is necessary to prevent the economy from overheating.

The RBA Board has been adamant that its decision to raise the cash rate at every opportunity over the past year has been to quell the scourge of rising inflation. Now that inflation has peaked and consecutive monthly figures indicate a notable deceleration, could this compel the Board to leave the cash rate untouched during its meeting next week?

If this is the case, it would be the first time in 12 months that the RBA has not imposed an increase to the cash rate. Since May 2022, the cash rate has risen 350 basis points to 3.60%.

Modest retail sales and deteriorating savings reinforce call for cash rate pause

Earlier this week, the ABS reported that Australian retail turnover rose just 0.2% in February 2023. This follows a 1.8% rise in January 2023. These figures illustrate that spending appears to have levelled off.

At the beginning of March, the ABS reported that the household savings ratio declined sharply between September and December 2022, to its lowest level in over five years.

The household savings ratio is calculated by dividing household savings by household disposable income. A lower household savings ratio indicates that households are spending more and saving less.

No guarantee RBA will pause in April

In his statement on the latest monetary policy decision earlier this month, RBA governor Philip Lowe said the Board expects that further tightening of monetary policy will be needed to ensure that inflation returns to target.

“The monthly CPI indicator suggests that inflation has peaked in Australia. Goods price inflation is expected to moderate over the months ahead due to both global developments and softer demand in Australia. Services price inflation remains high, with strong demand for some services over the summer,” Lowe said.

Three of the big four banks forecast another 25 basis points hike to the cash rate in April. However, Westpac says that the RBA will pause next month before hiking again in May, while CBA expects cash rate cuts before next year.

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