Melbourne Institute’s Inflation Gauge Reinforces Outlook for RBA Rate Reductions in 2025
Expert economists agree that the RBA should not cut interest rates in February.
The Melbourne Institute of Applied Economic and Social Research has published its monthly Inflation Gauge report which estimates underlying inflation has increased by 0.7% in the December quarter, confirming a steady decline since March 2024. This suggests that inflationary pressures are easing, creating an environment conducive for the Reserve Bank of Australia (RBA) to pursue an interest rate-cutting cycle in 2025.
Associate Professor Sam Tsiaplias from the Melbourne Institute does not believe a rate cut should commence as early as February 2025 –
“Annual headline inflation has been within the Reserve Bank’s 2-3 per cent target band since July 2024. That said, average quarterly inflation up to December 2024 increased relative to September 2024, highlighting the potential for inflationary risks. Therefore, although there is a downward trend in inflation, it may be prudent to take a wait-and-see approach, at least for a few months, before committing to cutting interest rates.”
The good news is that Associate Professor Tsiaplias does believe that interest rates should start falling in 2025, as a delay could lead to negative economic consequences –
“If rate cuts commence too early, that may create additional inflationary pressure, hampering the ability to fully commit to a series of rate cuts in the future. On the other hand, waiting too long to cut rates constitutes an unnecessary handbrake on economic conditions. Overall, coupling the clear decline in inflation with the material risks associated with waiting too long to cut rates, it appears prudent to start cutting rates in 2025.”
Graph compares annual inflation as per the Melbourne Institute Inflation Gauge with the corresponding value from the Australian Bureau of Statistics (ABS) Consumer Price Index (CPI).
Dr Issac Gross from Monash University believes that the latest Melbourne Institute Inflation Gauge strengthens the case for an interest rate cut when the RBA meets in February –
“If confirmed by the official ABS statistics to be released at the end of the month, it would indicate that underlying inflation has returned to the RBA’s target band, paving the way for gradual interest rate cuts throughout 2025. The RBA will slowly roll out the interest rate cuts as the strong labour market means there is still a risk that inflation could bounce back.”
So how long will Australians need to wait for cost-of-living pressures to ease? Dr Gross says that government subsidies for power bills and rent assistance add a layer of complexity –
“While these one-off price movements are typically excluded through the process of “trimming” large price rises or falls, the significant number and size of these subsidies mean that even the trimmed mean may be partially affected. This may be one reason the RBA could wait until May to ensure inflation has moderated before beginning to cut interest rates.”
The Melbourne Institute’s Inflation Gauge has been running since 2002 and is based on the collection of a large data set of monthly prices for goods and services consumed by Australian households. The prices are collected from Australian firms and organisations (for example, fruit and vegetable prices, and furniture prices) and span each of the expenditure classes in the ABS CPI. In so doing, the Inflation Gauge provides a timely, monthly assessment of inflation in Australia that is used by the public sector, private organisations and economists to understand inflationary pressures.