Inflation Drop In May Brings Hopes About Pause on Interest Rate Hikes

Inflation Drop In May Brings Hopes About Pause on Interest Rate Hikes
A shopper wearing a mask walks past a shop displaying sales signs during the Boxing Day sales in Sydney, Australia, on Dec. 26, 2020. (David Gray/Getty Images)
Alfred Bui

A surprise drop in inflation in May has strengthened speculations about a pause on the Reserve Bank of Australia’s (RBA) aggressive interest rate hiking cycle.

However, it is still too early to conclude that inflation has been successfully tamed.

According to the Australian Bureau of Statistics (ABS), the monthly CPI (consumer price index) plunged from 6.8 percent in April to 5.6 percent in May.

The latest inflation figure was well below the 8.4 percent peak in December 2022 and caught markets and economists off-guard.

“This month’s annual increase of 5.6 percent is the smallest since April last year,” ABS head of prices statistics Michelle Marquardt said.

“While prices have kept rising for most goods and services, many increases were smaller than we have seen in recent months.”

The sharp fall was mainly driven by a 6.7 percent decrease in automotive fuel prices in May due to increased global oil production and a stronger Australian dollar resulting in cheaper import fuel.

Holiday travel and accommodation also contributed to the drop in CPI as the spending category fell 11.3 percent in the year to May.

However, the significant price rises in housing, food and non-alcoholic beverages, furnishings, household equipment and services categories offset all the downward movements in prices.

Staff members assist shoppers at Costco Perth on March 19, 2020 in Perth, Australia. (Paul Kane/Getty Images)
Staff members assist shoppers at Costco Perth on March 19, 2020 in Perth, Australia. (Paul Kane/Getty Images)

Specifically, housing prices jumped 8.4 percent in the 12 months to May, down from 8.9 percent in April.

Low vacancy rates caused annual rents to climb from 6.1 percent in April to 6.3 percent in May.

In addition, food and non-alcoholic beverages rose by 7.9 percent, and furnishings, household equipment and services saw a six percent growth during the period.

While the drop in the headline inflation figure appeared to be significant, a closer look revealed that the decrease would have been much softer if volatile items such as automotive fuel, holiday travel and fruit and vegetables were removed from the CPI basket.

In that sense, underlying consumer prices would have dipped to 6.4 percent in May, slightly lower than the 6.5 percent rise recorded in April.

Implications of the Fall in May’s CPI

Although the sharp fall in May’s CPI has led to speculations about a potential pause on the official cash rate in July, some economists believed the bank would still opt for a hike.

Pointing to the higher-than-expected lift in rents and an acceleration in services inflation in many spending categories, Barrenjoey economist Jo Masters said concerning economic data would likely weigh on the RBA’s interest rate decision in the week commencing July 3.

“And these are items where prices almost never fall, so they take a very long time to come out of the inflation data,” the economist said, noting that she was leaning towards another round of rate increase.

Echoing the sentiment, ANZ Bank economists thought the underlying inflation measures were not so encouraging.

The economists then forecasted that the RBA would continue to raise the cash rate in July and August.

“Though given the last two decisions were described by the RBA Board as ‘finely balanced,’ there is a chance the monthly CPI data could shift the RBA to a pause in July,” they said.

“This would shift the timing of our forecast peak cash rate of 4.6 percent but not the level of peak.”

While HSBC Bank economist Paul Bloxham said the latest CPI data was generally good news for Australia, he believed inflation still remained very strong.

“Another way to think about this is that the easier part of the disinflation process, the parts largely related to the [COVID-19] pandemic and commodity market disruptions, are now coming through in the numbers, but the ’stickier' parts of inflation are still yet to fade,” he said in comments obtained by AAP.

As such, Bloxham warned it was too early to “declare victory in the inflation fight.”

Alfred Bui is an Australian reporter based in Melbourne and focuses on local and business news. He is a former small business owner and has two master’s degrees in business and business law. Contact him at [email protected].
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