Australia’s Melbourne Institute inflation gauge fell 0.4% m/m in June, following a 0.3% decline in May, as lower fuel prices pulled the index down. The y/y rate eased to 3.9% from 4.4%, reinforcing a second straight month of softer price readings. Both headline and underlying measures moved lower.
The trimmed mean measure dropped 0.5% m/m after a 0.1% fall previously, taking its y/y pace down to 2.8% from 3.6%. The latest snapshot indicates easing pressure across the inflation basket and suggests disinflation is becoming more established. Against that backdrop, market pricing for 35bp of tightening by year-end looks more vulnerable if softer inflation momentum persists, potentially testing the Reserve Bank of Australia’s neutral stance.
Australian Inflation Drops Sharply As Market Bets On Rate Hikes Become Riskier
We are seeing clear signs that Australian inflation is cooling faster than many expected, with price gauges falling for a second straight month in June. The underlying trimmed mean inflation rate has now dropped to 2.8% year-on-year, which is well within a normal range. This suggests the battle against high prices is largely being won.
This new data makes the market’s current bets on more rate hikes from the Reserve Bank of Australia (RBA) look very risky. With inflation pressures easing this quickly, it becomes difficult for the RBA to maintain a neutral, let alone hawkish, stance. The 35 basis points of tightening priced in by year-end now seems highly unlikely.
Recent official figures support this view, as the latest quarterly CPI from the Australian Bureau of Statistics also undershot forecasts, coming in at 3.7%. Furthermore, the national unemployment rate has edged up to 4.2% in the last report. This combination of slowing inflation and a softening labor market builds a strong case for the RBA to pause or even consider easing policy.
Implications For Traders: Interest Rates, Bonds, And The Australian Dollar
For derivatives traders, this points to positioning for lower interest rates ahead. We believe there is value in buying Australian government bond futures, as their prices should rally when the market abandons its bets on rate hikes. Interest rate swaps that position to benefit from falling short-term rates also appear attractive over the next several weeks.
This outlook will also likely pressure the Australian dollar. As expectations for further rate hikes fade, the currency’s yield advantage diminishes, making it less attractive. We are considering strategies like buying AUD/USD put options to profit from a potential depreciation of the Aussie dollar.
We have seen this playbook before, such as in mid-2019 when the RBA pivoted from on-hold to cutting rates as the economic data softened unexpectedly. Markets that were slow to react then were left behind. The current data suggests a similar pivot could be on the horizon, creating an opportunity for those positioned correctly.
