Originally published in The Australian Financial Review on 29 September 2024. See the original article or download the article.

By Angus Coote, Co-Founder

By the end of next quarter Australia would have been in a per capita recession for two years, assuming the current trend of weak growth continues into the fourth quarter.

If you exclude immigration, the country has not experienced such sluggish economic performance since the recession of the 1990s. And if current conditions persist, we are edging closer to a full-blown technical recession regardless of the impact of immigration.

The Reserve Bank after the last board meeting acknowledged the impact of immigration and noted the resilience of consumer demand, which included “spending by temporary residents such as students and tourists”.

The central bank faces a difficult balancing act as it works to convince the public that it will hold off on cutting rates until inflation is decisively under control. However, by doing so, it risks keeping interest rates too high for too long and potentially tipping the economy into a technical recession, which is what bond markets refer to as a “policy error”.

Momentum is critical and right now, the economy is at genuine risk of stalling. It’s no surprise then that the bond market has already priced in almost 50 basis points of cuts by February and 140 basis points by December next year.

Globally, inflation is becoming a story of the past. In the US, UK, Canada and across Europe, consumer price index (CPI) figures have been falling rapidly, nearing or hitting central bank target bands.

Central banks in these regions – and others – have already begun cutting rates, in some cases multiple times. The US Federal Reserve notably kicked off its rate-cutting cycle with a substantial 50 basis point reduction. The question now is: what do they know that we don’t?

While Australia still has inflation above the target band and slightly less restrictive rates than other countries, our situation isn’t drastically different from the rest of the world.

We emerged from the COVID-19 lockdowns about six months later than most, and our inflation peaked roughly six months later than others as well. So, it’s likely that inflation in Australia will decline later as well. Recent data reinforces this expectation.

Australia’s trimmed mean CPI, the key inflation measure tracked by the RBA, is trending below the central bank’s year-end forecast. The August figure came in at 3.4 per cent, just under the RBA’s year-end projection of 3.5 per cent.

With falling oil and commodity prices (excluding gold), a stronger Australian dollar, a sluggish Chinese economy, collapsing goods prices, more moderate immigration, and potential easing on the services side, it’s plausible that inflation could return to the target band much sooner than the RBA anticipates.

There’s a very real possibility that the RBA could cut interest rates at one or both of the remaining meetings this year.

Yet, as recently as last month, the RBA suggested the possibility of further rate hikes and ruled out any chance of cuts this year. You’d think the misguided forward guidance of the past would be behind us, especially after the infamous “no rate hikes until 2024” misstep.

However, the central bank seems intent on maintaining its cautious stance, despite clear signs that inflationary pressures are easing.

On the contrary, I believe there’s a very real possibility that the RBA could cut interest rates at one or both of the remaining meetings this year, in November or December. A single negative data point could prompt the central bank to pivot, much like the Fed, shifting focus from inflation to preserving growth.

It was particularly telling when RBA governor Michele Bullock acknowledged last week that there had been board discussions about potentially revising their guidance. This signals a growing readiness to adjust course if the economic outlook deteriorates further.

While Australia didn’t raise interest rates as aggressively as some other countries, we have the most variable mortgage market in the developed world, where rate increases are passed on to borrowers almost immediately – except for the savvy few who locked in five-year fixed rates back in 2020-2021.

The impact of 425 basis points in rate increases since 2022 is clear when considering indicators such as falling business and consumer confidence, plummeting savings rates, per capita consumption declines, rising corporate insolvencies and the ongoing per capita recession.

Inflation may still be above the target band for now, but if the economy continues on its current trajectory, it won’t be long before inflation becomes a thing of the past.

Lastly, while the bond market has been critical of the rate increases over the past few years, it is now positioned more favourably than it has been in decades, as the global central bank cutting cycle begins and yields approach multi-decade highs.

The Australian Government Bond Index returned 7.8 per cent in 2019, the last time the RBA cut rates (excluding the COVID-19 period). Notably, that return was achieved from a much lower starting yield with only 75 basis points in cuts.

According to the bond market, the upcoming rate-cutting cycle in 2024 and 2025 is expected to far exceed this, presenting promising opportunities for investors.