AUSTRALIA: Positive Core Inflation Gap Implies Too Early For Rate Cuts

With temporary state and federal government electricity rebates for households impacting headline inflation, the RBA has said that “underlying inflation is more indicative of inflation momentum”, even though officially its focus is headline as Governor Bullock reiterated before the Senate economics committee last week. Thus we have re-estimated our Australian OCR policy reaction function using quarterly trimmed mean CPI.

• We have also updated it for the revised RBA staff forecasts published in the November Statement of Monetary Policy. There were slight downward revisions to the trimmed mean CPI profile, while GDP growth was revised down.
• Our equation uses the trimmed mean inflation gap with the target band mid-point of 2.5% and the GDP output gap with a current trend growth estimate at around 2.25%. It is worth noting that econometric calculations are only estimates and not predictions.
• The equation with core inflation points to rates needing to stay roughly where they are to be consistent with economic fundamentals and their outlook. If anything it is implying another 25bp of tightening by end-2025 with around a 25% chance of a hike each quarter. In contrast market pricing has around 50bp of easing priced in by Q4 2025.
• The model is also “cautious” not signalling the need for any easing as there is a positive inflation gap until end-2026, when it closes but is still yet to turn negative. The equation is forward looking using the one quarter lead of the core inflation gap. 

Australia OCR policy reaction function with trimmed mean CPI %