Australia Q4 inflation slows sharply to two-year low, bringing rate cuts nearer

Australian consumer price inflation slowed more than expected to a two-year low in the fourth quarter, while a sharp deceleration in core inflation prompted markets to bring forward bets of rate cuts.

The price data would be a welcome relief for the Reserve Bank of Australia as it prepares to deliver its first policy decision of the year next Tuesday.

Futures rallied to imply around a 64 per cent probability of a first rate cut in June, up from 54 per cent before the data. A quarter-point cut was now more than fully priced for August and the total easing for 2024 moved to 48 basis points, from 42 basis points.

Data from the Australian Bureau of Statistics on Wednesday showed the consumer price index (CPI) rose 0.6 per cent in the fourth quarter, under market forecasts for a 0.8 per cent increase.

The annual pace of CPI inflation slowed to 4.1 per cent, from 5.4 per cent, and was well below the peak of 7.8 per cent in December 2022.

More encouragingly, the CPI rose 3.4 per cent year-on-year in the month of December, down sharply from 4.3 per cent in November and down more than two percentage points in three months.

A closely watched measure of core inflation, the trimmed mean, rose 0.8 per cent in the fourth quarter, under forecasts of a 0.9 per cent increase. The annual pace slowed to 4.2 per cent, from 5.2 per cent.

The Australian dollar eased 0.3 per cent to $0.6585 after the data, while three year bond futures extended earlier gains to 96.37, the highest level in two weeks.

The RBA has already raised interest rates by 425 basis points to a 12-year high of 4.35 per cent since May 2022 to tame runaway prices. It also left the door open to further tightening if necessary to meet its annual inflation target of 2-3 per cent.

The central bank had expected inflation to ease to 4.5 per cent by December and to return to its target band in late 2025. The central bank will provide updated forecasts next Tuesday.

The economy has evolved largely as the RBA had expected over the past two months, with the labour market loosening, consumer spending soft amid costs of living pressures and goods disinflation continuing.

However, the overseas landscape has changed drastically. With inflation abroad falling rapidly, markets are betting the Federal Reserve and European Central Bank would be soon cutting interest rates. They see the first rate cut from the Fed in May and first easing from the ECB in April.