Retailers are now betting on an interest rate cut in August after annual inflation dropped to 2.1% in the year to June, down from 2.4% previously.

During the same period, underlying inflation eased to 2.7%, aligning with Reserve Bank of Australia (RBA) expectations and strengthening the case for a potential rate cut just two months ahead of the critical Black Friday and holiday shopping season.

Observers say the RBA’s preferred inflation gauge has fallen to its lowest level in three and a half years, paving the way for a possible interest rate reduction as early as next month.

A key factor in the decline was government intervention, with the Albanese Labor government introducing energy bill subsidies as part of its pre-election strategy to provide cost-of-living relief.

Earlier this month, the RBA surprised economists by holding the cash rate steady at 3.85%. Governor Michele Bullock explained the pause was based on timing, stating the bank needed more evidence that inflation was sustainably within its 2–3% target range.

“We don’t want to end up having to fight inflation again. We want to make sure we’ve nailed it,” Bullock said.

She also cautioned against reading too much into the headline CPI number, which came in at 2.1%, saying, “We don’t think inflation in a sustainable way is that low – we think it’s higher.”

Economists surveyed by Reuters forecast underlying inflation at 0.7% for the June quarter, or 2.7% annually, in line with the latest figures.

Ahead of the CPI release, money markets had already priced in a more than 90% chance of a 0.25 percentage point rate cut at the RBA’s August board meeting.

While the RBA expects inflation to sit at the lower end of its target band for now, Bullock has warned it could rebound towards 3% by year’s end as temporary government electricity rebates expire.

ANZ Chief Economist Richard Yetsenga noted that while inflation is easing, the pace has slowed, suggesting only modest rate cuts are likely in the near term.

Supporting that view, the latest ANZ-Roy Morgan Inflation Expectations survey for June showed a slight uptick to 4.8%, up 0.2 percentage points from May and consistent with the year-to-date average.