Hot US inflation stalks clamour for RBA rate cut

Hotter-than-expected US inflation may force the Federal Reserve to leave interest rates on hold through 2025 and give the Reserve Bank of Australia food for thought at the margin ahead of its anticipated interest rate cut next Tuesday. 

US consumer price index (CPI) inflation for January 2025 climbed to 3% overnight, versus 3.1% for a year earlier in January 2024. Excluding volatile items such as food and energy, the core inflation rate rose to 3.3%, well ahead of the Fed's 2% goal.

Stephen Miller, the chief economist at GFSM Funds Management, warned that core US 3-month annualised inflation is now running at a "worrying" 3.8%, versus 1.7% at its trough in July 2024. 

Consumer prices in the US started to rebound after the Fed delivered a surprise 50 basis point in September 2024, but Mr Miller said the latest data is highly unlikely to prevent the Reserve Bank from lowering Australian rates next Tuesday. 

"I don't think [the overnight data] will be sufficient to delay that, but it will give the RBA caution in framing any statement and they won't want to encourage the impression that there'll be sequential rate cuts," Mr Miller said.

"It will be this is a one and done cut for the time being, rather than one on the road to many. They'll want to have a bit of a rest after this get a bit more data and maybe in a couple of meetings time return to the idea of more cuts.

"The impact of this data for the RBA is really on the margin. It's through the exchange rate as it probably implies a higher US dollar and that maybe implies some higher inflation here, but given the weakness in private sector activity any pass through is likely to be very limited."

Overnight in the US, the greenback advanced as traders pushed back expectations of the timing of an interest rate cut to September, with its likelihood now priced at a coin toss or 54.2%, according to the CME FedWatch tool. 

The yields on US 10-year government treasuries jumped nine basis points to 4.63% overnight as bond traders also pared back bets on a Fed rate cut in 2025. 

Shorter-dated Australian bond yields also jumped, with the 1-year government bond yield adding eight basis points to 3.97% and the Australian 5-year bond yield climbing 10 basis points to 4.08% as traders trimmed expectations for the Australian rate cut cycle. 

Other evidence

However, My Bui an economist at AMP's superannuation and investments team said she still expects the US Fed to cut rates one or two times in 2025 as its preferred inflation measure the personal consumption expenditure (PCE) is still falling. 

" I wouldn't rush to classify US inflation as sticky just yet," said Ms Bui. 

"The core PCE is [the Fed's] favourite measure and it has continued to fall since a year ago and is now 2.7%. Just last night, [Fed chair] Powell said not to over-interpret one or two good or bad inflation readings, and he said the Fed targets PCE rather than CPI. 

"We do expect the RBA to acknowledge pressures from abroad in terms of tariffs and trade wars [in its monetary statement]. But we expect them to cut as inflation has come in under their forecasts, also GDP is below forecasts and we expect they may have to revise down GDP forecasts."

Elsewhere, HSBC's chief economist Paul Bloxham said the overnight data definitely increases the risk the Fed doesn't cut as much as expected in 2025. 

"That's the way the market has responded," Mr Bloxham said. "The Fed watches the PCE most closely but there's information in the CPI you can then translate into what it may mean for core PCE. The fact the CPI measure was a reasonable amount stronger than expected I guess is a risk you don't get as much disinflation in core PCE either. So there's def information in the CPI the Fed will have watched very carefully."

Mr Bloxham said the Reserve Bank will watch US inflation data "very closely" and predicted Australia's central bank will deliver a "hawkish cut" next Tuesday where they warn the market it will need more evidence of disinflation before it signals a willingness to cut futher. 

Shares climb, market bets on rate cut

Australian shares raced to a record high of 8566 points last week in anticipation of a rate cut and both National Australia Bank and Westpac have already moved to cut fixed rates on mortgages for home loan borrowers. 

While interest rate futures traders are pricing a more than 90% chance the RBA loweres rates 25 basis points from 4.35% to 4.1%. 

The rate cut clamour gathered steam after December quarter core inflation data -stripping out volatile items -  dropped to 3.2%, below the RBA's November forecast of 3.4%. 

Mr Miller said the Reserve Bank is unlikely to disappoint the rate cut throng, but that US inflation gives it something to chew on. 

"The US shows once the inflation genie is out of the bottle it's very hard to get back in and now in the US there are signs inflation is sticky at a minimum and there are tariff policies in the pipeline likely to aggregate inflation rather than dissipate it. Having said that things can turn quickly, but it's certainly not implausible the Fed is on hold all year now."