Australian inflation fell in May (-0.7%m/m) as the federal excise tax cut saw fuel prices drop almost 12% after their 7% decline in April. This was the largest fall for a single inflation reading since the June quarter at the outset of the pandemic. Annual headline CPI slowed from 4.2% to 4%, defying expectations to rise to 4.3%. However, underlying inflation continued to rise, consistent with the domestic inflationary pressures that prompted the RBA to raise rates three times already this year before last week's decision to pause.
Headline inflation fell by 0.7% month-on-month in May after rising 0.4% in April. As alluded to above, that was the largest fall seen in either a single month or quarter since the start of the pandemic in 2020. The halving of the fuel excise tax (in effect until the end of June) saw an initial fall in average petrol prices of 7% in April and that was followed up by an 11.9% decline in May. At the weekend, the federal government announced a 1-month extension of the measure but a lower rate to smooth the increase to fuel prices that will come from the eventual return of the full excise tax.
Aside from falling fuel prices, holiday travel costs also had a significant influence of the decline in headline inflation in May. Domestic travel prices fell a little over 12% in the month following the Easter holiday period, while international travel declined slightly (-0.8%). This drove a decline in services inflation (-0.7%m/m), though it firmed slightly to 3.7% in annual terms.
The parts of the basket that pushed up most on inflation were groceries (0.6%) and housing construction costs (0.9%), both arguably increases the RBA would see as consistent with second-round inflationary pressures.
Taking a broader view, trimmed mean CPI increased in May, indicating that underlying inflationary trends remain in place. In the month, the trimmed mean rose 0.4% following April's 0.3% lift. This saw the annual pace increase from 3.4% to 3.6%, in line with expectations. That implies underlying inflation has returned to its pace from around the middle of 2024.
Back then, the RBA had the cash rate set at 4.35%, the level where it currently sits after the three earlier hikes this year. Despite pausing its tightening cycle at last week's meeting, the RBA reaffirmed its hiking bias judging that upside risks to inflation had not abated - even after the US-Iran agreement to reopen the Strait of Hormuz. Markets price the chance of another RBA hike this cycle at around 50/50.
