Market expectations of an official rate cut at the Reserve Bank’s May board meeting have weakened after the release of fresh inflation data on Wednesday.
While many commentators focused on the fall in headline inflation in the March quarter, the rise in underlying inflation spooked futures traders who ratcheted down the likelihood of a rate cut next month to 50 per cent.
Before the publication of the inflation data, futures traders had put a 75 per cent probability on a May rate cut.
“The rise in the underlying measure of inflation has caused future traders to reprice the probability of a May rate cut to a 50-50 call,” said leading economist Stephen Koukoulas.
“The economic data to validate a further rate cut might not be there for the time being.”
In the past decade, the RBA has attached greater weight to the underlying inflation measure, which strips out the effect of volatile movements in prices of consumer products.
The modest 0.2 per cent rise in headline inflation for the March quarter was mainly attributable to a near-record plunge in petrol prices.
When the impact of that extreme movement is taken into account using the formula for calculating underlying inflation, consumer prices actually rose by 0.6 per cent during the quarter.
According to the underlying measure, Australia’s annual inflation rate is now tracking at about 2.35 per cent.
This means that underlying inflation is now tracking above the 2.25 per cent level when the RBA last cut rates in February.
The central bank risks exerting more pressure on this measure of inflation if it reduces interest rates next month.
Stock market reacts negatively to inflation news
Local share investors reacted immediately to the underlying inflation numbers by driving down the value of bank stocks.
According to Mr Koukoulas the higher-than-expected trend rate for underlying inflation led to a sell-off of bank stocks.
“This is a rate-sensitive stockmarket,” he said.
“Bank stocks are now being hit on assumptions that rates won’t change next month.”
The four major banks – ANZ, NAB, CBA and Westpac – posted the biggest declines among blue chip stocks on Wednesday with each having fallen by around one per cent after the inflation data was released by the Australian Bureau of Statistics.
Listed regional banks such as Bank of Queensland and Suncorp underperformed the broader market, falling by as much as 1.5 per cent each.
Mr Koukoulas said although the economy was still working through a patchy period, recent data releases indicated that it had strengthened since the February board meeting.
“While consumers are still cautious, the labour market is much stronger than earlier in the year,” he said.
Mr Koukoulas said that the rise in employment and underlying inflation could tip the scales against another rate cut next month.
HSBC chief economist Paul Bloxham said the inflation data surprised the market.
“Underlying inflation surprised the market slightly to the upside in the first quarter, although it remains well contained,” he said.
“Add to this the recent run of better jobs and retail sales data, as well as the still booming Sydney housing market, and the May meeting is likely to be another close call.
“The market is pricing a 50 per cent chance of a cut in May.”
Reserve Bank says it found no evidence of ‘rate leaks’
The Australian Securities and Investments Commission is continuing to investigate whether Reserve Bank staff were linked to suspected insider trading in the lead-up to the February and March official rate announcements.
In the minutes before both announcements were made public, there were sharp movements in the value of the Australian dollar against the greenback.
According to the minutes of the RBA board’s April meeting, internal investigations found no evidence of leaking by central bank staff.
“Members were aware of the investigations currently being undertaken by the Australian Securities and Investments Commission and were informed that internal work since the March meeting had not identified any evidence of procedural lapses or conduct that could have led to the early release of relevant information,” the RBA minutes stated.
The RBA Board next meets on May 5.