Hot Take: Rate cuts are coming soon

The hotly-anticipated December quarter consumer price index (CPI) data were released earlier this morning. Effectively the last official piece of the Reserve Bank of Australia's (RBA) puzzle ahead of its 18 February rates decision, it's also the most important.

Breaking it down

Unlike the monthly data, the quarterly CPI contains price updates for all items in the basket. As has become all too familiar, various government subsidies distorted the headline measure, which came in at 2.4% in the December quarter:

Normally in such a scenario I would bypass the headline figure and look at the trimmed mean measure, which cuts out the bottom and top 15% of price changes, thereby 'looking past' such distortions. When you're trying to forecast inflation, looking only at the most stable 70% of prices is a perfectly reasonable thing to do: volatile items are just as likely to move in the other direction in the future, whereas stable prices are a better forecast of future inflation, which is what we care about for predicting possible rate movements.

In the December quarter, the trimmed mean indicator increased by 3.2%, only slightly above the RBA's target band:

However, there's one more problem. There are now so many government subsidies coming on and rolling off – energy, rent, public transport, childcare – that even the trimmed mean measure now includes some of the distortions, most notably rents:

"[E]ven with a substantial reduction rental inflation remains in the middle 70% of price changes and impacts the trimmed mean quite often. Even if it does get trimmed out it pushes some other low-inflation subgroup into the non-trimmed middle portion of the distribution which will lower the trimmed-mean inflation rate."

The CPI's value as a measurement of inflation has effectively been muted; the government really has proven Goodhart's law, which predicts that when a measure becomes a target, it ceases to be a good measure. It so desperately wanted to get measured inflation down that it made the measure itself unreliable.

However, there is a further option – at least until the December quarter national accounts data are released with broader measures of inflation, which will unfortunately come too late for the RBA's February meeting.