Tim Hext: Inflation is on the right path, but we’re not there yet

The latest quarterly CPI data shows inflation is on the right path. But there’s still more work to do, writes Pendal’s head of government bond strategies, TIM HEXT

• December-quarter inflation lower than expected
• Housing still needs to cool
• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

Inflation on track towards 3%

THE market was not disappointed with today’s December-quarter CPI inflation data.

The theme since early November has been inflation moderating globally — and today’s Australian numbers back that up.

The headline Consumer Price Index was 0.6% and underlying 0.8% for the quarter. Annual numbers were 4.1% and 4.2% respectively.

These numbers were slightly lower than expected due to electricity subsidies and international travel.

We also got a comparison of December 2023 with December 2022. Weak fuel prices saw that number at 3.4%.

The Reserve Bank is entering 2024 with inflation somewhere around 4% annually but with the three-month annualised number nearer 3%.

Next week’s RBA statement will urge caution

The RBA will be encouraged by these inflation numbers.

Their panic rate hike in November looks like a mistake — but they will claim some credit for the easing pace.

Their caution will come from non-tradable inflation. Non-tradables are prices largely driven by domestic factors — predominately services.

The RBA can have more impact in this area than in tradables, where we are a global price taker.

Non-tradable inflation has eased from 6% to 5.4% but this is still inconsistent with the RBA inflation band.

The RBA would need to see non-tradable inflation nearer 4% if inflation was to fall closer to the 2-3% target band. Non-tradables are around two-thirds of the CPI.

The biggest driver of non-tradable inflation is wages, which are now around 4%.

Therefore there should be some optimism that over 2024 non-tradable inflation can ease further — though recent hikes in areas like education will continue to put pressure on this.

The path of inflation this year

The key battleground for inflation remains housing, which makes up 22 per cent of the CPI.

New dwelling cost growth is easing, but at a slower rate than hoped.

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Rents are still growing, though closer to 5% than 10%. Utilities are held down by subsidies that will be reviewed later this year.

The RBA won’t gain confidence in the medium-term inflation path for inflation until they see housing moderate nearer to 4% in the CPI. (Housing CPI includes the cost of a new dwelling, rents and utilities but not house prices).

The RBA is expecting CPI at 3.9% by June and 3.5% by December.

They may tweak the June number lower but are unlikely to change the December number for now.

Implications for monetary policy

The market still has cash priced for 3.85% — or two cuts — by the end of 2024, with the first around September.

This is driven more by the fact the US is priced for 4% Fed Funds or 1.5% lower by year’s end.

The US is likely to deliver these cuts since their inflation is near target (unlike the RBA).

But the RBA should eventually deliver lower rates — and we think pricing is fair for now.

Hurdles include oil prices (which have sneaked higher in the past week) and resilient employment markets.

Yes, the long-and-variable lags of monetary policy could see last year’s hikes further weigh on the economy, accelerating the need for cuts.

But we think risks lie more to the latter than the former — which makes us still positive on duration.

About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.

Find out more about Pendal’s fixed interest strategies here

About Pendal

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

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