Q1’19 CPI makes strong case for 7 May RBA cut

The slow pace of inflation in Q1 makes a very strong case for a 25 bps reduction of the RBA’s policy rate on 7 May, to 1.25%.

The key trimmed mean inflation measure increased 28bps to be 1.6% higher over the year. This is a 24bps deceleration from the Q4’18 print of 1.84% (it has since been revised down to 1.82%).  Nor is the weak inflation pulse some figment of the trim’s construction. The weighted median measure increased by just under 10bps to be 1.24%yoy.

This took the average of the RBA’s two Core measures of inflation up ~19bps on the quarter to by ~1.42%yoy.  This is being held up by the higher prior prints.  The 2qma is a good balance between signal and noise, and on this basis core inflation was ~1.2%yoy.  Both the two-core qoq and the 2qma are below the low inflation prints of early 2016 (of 20bps and 1.26%).  These low prints led RBA Gov Stevens to cut the cash rate, despite a falling unemployment rate.

So coming into the May meeting, the facts are that domestic growth disappointed, inflation disappointed, global growth slowed, and the labour market cooled a little. There is some disagreement between the different data sets, but the story is substantially completed by CPI.

We learn a lot about the balance between supply and demand from the CPI release, and the message from the details of today’s report is that the output gap is widening — in line with the slow GDP data. This makes sense: the origin of the weakness is housing, and falling house prices are slowing consumption — so we should expect CPI to be weak.

That is exactly what we see — sequential slowing of CPI over the prior year.

The fact is that the current data means the RBA cannot present a credible case for a return of inflation to their 2.5% target within Gov Lowe’s term — with current monetary policy settings. So monetary policy must be eased.

The only reason i can think of to leave monetary policy unchanged at 1.5% would be to avoid the federal election–but that is a political act in itself.

The lack of progress toward the inflation target justifies a rate cut, notwithstanding mixed signals on growth. The least political thing the RBA can do is to follow their forecasting/policy process and deliver one.

I think the economic case for a 25bps cut is a slam dunk — because the economy can run hotter, and should be allowed to do so.