Australia is on a path toward deflation. RBA may cut rates more.

When you have a decelerating CPI you can bet that it is not due to inflationary conditions in your economy. And when there is talk about your central bank possibly cutting rates you are not worried about igniting monetary inflation that will shock up your CPI. You are talking about fighting deflation here. And that is the case of the Australian economy today.

Low inflation gives the RBA room to cut

July 6, 2009

A leading private sector inflation index, released the day before the July Reserve Bank meeting, reveals that inflation remains below the RBA’s target.

The TD Securities – Melbourne Institute Monthly Inflation Gauge found that prices rose by 0.4 per cent in June, but only 1.4 per cent in the year to June, well below the RBA’s target of 2 – 3 per cent for annual inflation.

Most economists are forecasting that interest rates will remain on hold this month – a poll of 19 economists by Reuters on Friday found that all 19 expected official rates to remain at 3 per cent.

However, June was the second consecutive month the index has come in with annual inflation below the Reserve’s target, and leaves the bank lots of scope to cut rates further in future months if it feels the economy needs an additional boost.Annette Beacher, a senior strategist at TD Securities, agrees that the Reserve Bank is likely to stay on the sidelines this month, but will at least consider a further cut at its meeting tomorrow.

“Inflation is set to continue undershooting the RBA’s target until mid-2010 – perhaps beyond. As a result, the RBA Board meeting tomorrow will no doubt discuss the case for an immediate interest rate cut,” she wrote in the report.

“On inflation grounds, the case is compelling but, as has been the case in recent months, the RBA is placing a lot of faith in the momentum in China to drag Australia out of recession and this may see the RBA, yet again, defer the rate cut decision to the following month.”

Professor Don Harding from the Department of Economics and Finance at La Trobe University says the figure will please the Reserve Bank board.

“The RBA will be well satisfied with these numbers, there is enough evidence of core inflation to suggest that fears of deflation were overdone for Australia at least but there is insufficient evidence of emergent inflation to warrant consideration of tightening – yet,” he wrote in the report.

The latest official interest rate decision will be announced publicly at 2:30pm (AEST) tomorrow.


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