Weaker than expected inflation for the first quarter of 2019 has boosted expectations the RBA will cut the cash rate when it meets next month.

The Australian dollar has taken another hit after inflation completely evaporated in the March quarter, boosting chances the Reserve Bank will drag the historically low 1.5 per cent cash rate even lower.

Annual inflation slowed to 1.3 per cent for the 12 months to 31 March after the consumer price index showed zero growth in the quarter, falling from 0.5 per cent in the previous three months and undershooting the weak 0.2 per cent expected by the market.

After three years of below-target inflation and GDP growth forecasts being revised downward, economists say the RBA could now cut the cash rate as soon as May – before the 18 May federal election.

The futures market had already priced in at least one rate cut before the end of the year, with many economists predicting two 0.25 percentage point cuts.
AMP Capital chief economist Shane Oliver highlighted weaker underlying inflation as the biggest surprise to come from the latest set of figures.

This averaged 0.2 per cent over the quarter and 1.4 per cent over the year, which missed consensus expectations of 0.4 per cent quarter-on-quarter and 1.7 per cent year-on-year.
"The RBA uses underlying inflation as the best guide to fundamental price trends in the economy because it excludes volatile price changes," Oliver said.
The largest price rises in the first three months of 2019 came from the usual seasonal sources:

  • Education
  • Medical services
  • Automotive prices
  • Food prices, particularly vegetables.

However, these were offset by price declines in fuel – particularly petrol prices, which fell sharply – along with travel costs, which commonly fall in the first three months each year in a post-holiday seasonal effect.

"The weakness in underlying inflation shows that businesses are still finding it challenging to lift prices in the face of ongoing spare capacity, intense competition and weak demand," Oliver said.

Downward pressure on prices, wages

He expects inflation to remain weak and gross domestic product growth to remain low in 2019, at about 2.3 per cent, which Oliver suggests will keep down pressure on prices and wages.

"The longer inflation undershoots the 2-3 per cent target, the greater the risk that the target will lose credibility,” Oliver said.

"This in turn will see low inflation expectations become more entrenched, making it in turn even harder to get inflation back to target."

Oliver believes lowering the inflation target would be a huge mistake, "that would see targeting lose all credibility and only lock in low inflation – and the risk of deflation – for longer".

Oliver has also revised his official interest rate outlook, now tipping a rate cut next month. This would be the first movement since August 2016, when the RBA dropped the official cash rate to a historic low of 1.5 per cent.

Previously, he expected the first of two rate cuts to be delayed until after the election.

Deep underlying issues

APAC economist Callam Pickering said Wednesday's figures pointed to deep underlying issues across the Australian economy, and created a compelling argument for the RBA to cut.

"These are problems that, if the past three years are any indication, won't go away on their own," Pickering said.

"Rather than waiting a few months for employment growth to converge with the myriad of weak economic measures".

Employment, wages remain disconnected

Sarah Hunter from BIS Oxford Economics said the data suggested that core inflation would undershoot the RBA's projection of 1.75 per cent year-on-year in the June quarter, increasing pressure to cut the cash rate in the second half.

"For now at least, the disconnect between employment growth and wage increases is continuing," Hunter said.

The Australian dollar, which was already falling, immediately dropped another 0.5 cents against the US dollar on the data's release. The Aussie was trading at 70.36 US cents at 1.30pm.

The most significant rise in the March quarter was the 7.7 per cent increase in vegetable prices as drought and bad weather hit food production, while there was a 4.2 per cent rise for secondary education, and a 2.4 per cent rise for motor vehicles.

The rises were offset by an 8.7 per cent fall in automotive fuel, a 3.8 per cent fall in domestic travel and accommodation, and a 2.1 per cent fall in international travel and accommodation.

Interest rates will next be considered by the RBA when it meets on Tuesday 7 May.