Australia's headline Consumer Price Index declined 0.7 percent month-on-month in May, beating expectations of a 0.4 percent fall. Year-on-year growth dropped to 4.0 percent from 4.2 percent, well below the March high of 4.6 percent and significantly undershooting the RBA's prior forecast of 4.8 percent for the second quarter.
The miss has forced a re-evaluation of the RBA's near-term policy path. The 2-year Australian government bond yield has fallen approximately 35 basis points from its late-March peak of 4.80 percent and now trades at 4.45 percent, reflecting the market's removal of an aggressive August rate hike from its pricing.
Core inflation tells a different story. Australia's trimmed mean rose 0.4 percent month-on-month, above the expected 0.3 percent increase. The year-on-year core reading reached 3.6 percent, exceeding the 3.5 percent forecast and marking the second-highest monthly print on record.
This divergence between headline and core inflation leaves the RBA with a structural problem: headline CPI is easing while underlying price pressures remain sticky. The 10-year Australian government bond yield trades at 4.78 percent, down from a short-term high of 5.11 percent in late March, as economic activity data including second-quarter PMI figures signal easing price momentum.
The 2-10 curve spread stands at 32.84 basis points, consolidated near 33 basis points after a period of flattening. The persistence of core inflation has embedded an inflation risk premium in the long end of the curve that caps further spread compression.
Adam Bowe, head of Australian portfolio management at Pimco in Sydney, said Australia's rate-hike cycle is "fully priced" and economic cracks are becoming visible. He said Australian bonds, particularly in the five- to 10-year section of the curve, appear attractive.
