This Wednesday at 11:30 am, all eyes will be on the Australian Bureau of Statistics (ABS) as it announces the December quarter inflation rate. Economists, bankers, and anyone with a mortgage will be glued to their screens, hoping for good news. A low inflation rate could hint at a potential interest rate cut when the Reserve Bank of Australia (RBA) meets on February 17. But hold on—it’s not that simple.
Here’s the thing: the RBA doesn’t cut rates just because inflation dips. Their main focus is on unemployment, not inflation. Why? Because interest rate decisions aim to shape the future, not react to the past. And while inflation matters, unemployment ranks higher in the RBA’s priorities. Essentially, central banks use unemployment as a tool to manage inflation—raising rates to cool demand and, unfortunately, accepting some job losses in the process.
Right now, unemployment isn’t rising—it’s falling. Last January, it was at 4.1%, then dropped to 4.2% in July, and now sits at 4%. That makes a rate cut in February highly unlikely. Historically, the RBA has only cut rates during periods of falling unemployment twice: during the Asian financial crisis in the late 1990s and between 2014 and 2019, when inflation was too low.
Neither situation applies today. Inflation is running high, and while the Australian dollar has dipped, it’s not in freefall like it was in the late '90s.
What’s NAIRU?
To decide what’s next, the RBA looks at a concept called NAIRU (the non-accelerating inflation rate of unemployment). It’s a clunky acronym economists use to estimate the “right” level of unemployment needed to keep inflation stable. Right now, the RBA estimates that NAIRU is around 4.5%. Since current unemployment is at 4%, there’s no pressure to cut rates.
By the time the RBA meets in February, the December inflation numbers will be six weeks old—interesting, but not the most relevant factor. They’ll focus more on what unemployment might mean for wages, demand, and future inflation.
Adding to the complexity, the ABS’s January unemployment data and the latest wage growth figures will come out after the February meeting. So, the RBA will have to make its decision without the latest updates.
Could the RBA cut rates?
Some experts believe the RBA might be overestimating NAIRU. Treasury Secretary Stephen Kennedy thinks it’s closer to 4.25%, and other economists suggest it could even be 4%. Commonwealth Bank’s Gareth Aird recently pointed out that wages growth hasn’t been as strong as the RBA expected. If wages remain moderate, inflation might stabilize without unemployment needing to rise much further.
Still, don’t hold your breath for a February rate cut. The RBA is famously cautious. While they’ve acknowledged that progress in the labor market might be stalling, their December meeting minutes suggested they’re not in a hurry to change course. “In due course” was the phrase they used when discussing the possibility of easing monetary policy—hardly a signal of urgency.
So, if you’re hoping for lower rates, it might take another meeting or two before the RBA makes a move.
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