Australian inflation is continuing to surprise on the downside and is tracking below RBA forecasts. For the fifth month in a row monthly CPI inflation came in weaker than expected in February, with a monthly rise of just 0.2% MoM and annual inflation unchanged at 3.4% YoY. While fuel and education costs rose sharply and housing costs continue to rise at a rapid rate, this was offset in the month by greater than expected weakness in costs for holiday travel, utilities and many food items. The continuing faster than expected fall in Australian inflation provides support for our view that the RBA will start to cut rates from June. However, in the interim the RBA is likely to remain cautious and the risk remains high that the combination of the economy still growing, the stronger than expected labour market, upside risks to wages growth (flowing from another large increase in aged care workers wages and the upcoming minimum and award wage cases), along with the revamped Stage 3 tax cuts will see the start of rate cuts pushed back to August or September.

 

Inflation is coming down in most economies around the world. Eurozone inflation, having peaked at 10.6%, is now back to 2.4% and within its “normal” historical range. Surveys of purchasing managers (PMIs) have been heading higher, which is supportive for global growth and strength in commodities, particularly when combined with a tighter supply environment. 

 

In the US, the Institute for Supply Management (ISM) index entered expansionary territory for the first time since September 2022. A similar manufacturing survey in China also delivered its highest reading in 12 months. Initially this manufacturing strength was taken negatively, but as we received ISM services and labour data, the market changed its tune. Payrolls were a big beat, although this was offset by a rise in labour force participation and moderation in wages. This points to an economy with big supply-side tailwinds, supporting the ability to grow strongly while keeping inflation in check and avoiding overheating. 

 

Progress on inflation should keep the US Federal Reserve on track to cut rates this year, though good economic data may limit the pace of the cutting cycle. The market is now pricing a 53% probability for a June cut in the US. The total of implied expected cuts for 2024 has fallen to 67bps.

 

Easing inflation pressures, central banks moving to cut rates and prospects for stronger growth in 2025 should make for good investment returns this year. However, with a high risk of recession and share market valuations no longer positioned for recession and geopolitical risks, it’s likely to be a rougher and more constrained ride than in 2023.

 

Bonds are likely to provide returns around running yield or higher, as inflation slows, and central banks cut rates.

 

Unlisted commercial property returns are likely to be negative again due to the lagged impact of high bond yields & working from home.

 

Australian home prices are likely to see more constrained gains compared to 2023 as sustained higher interest rates constrain demand and unemployment rises. The supply shortfall should provide support though and rate cuts from mid-year should help boost price growth later in the year.

 

Cash and bank deposits are expected to provide returns of over 4%, reflecting the back up in interest rates.