The Reserve Bank delivered its fifth rate hike of the year, lifting the cash rate by 25 basis points to an 18-year high of 4.85%.
The case for another hike had strengthened. Inflation has remained persistently high and broad-based, while domestic capacity pressures appear greater than previously thought. Productivity growth remains weak and materially higher global energy prices stemming from the Middle East conflict have added another source of inflationary pressure. Against that backdrop, the RBA judged it needed to lean harder against inflation.
The bigger question is, what happens next?
There were two important take-aways from the decision. First, the RBA repeated that it would continue to do what it considers necessary to bring inflation sustainably back to target, but removed the previous reference to “including increasing the cash rate further if needed”. Second, the decision was not unanimous, with the Board voting 6-3 to lift the cash rate. Together, these changes suggest the threshold for further tightening may be higher, although the RBA has certainly not declared the tightening cycle over.
Our base case is that this is the peak. But, as with the previous decision, we cannot be fully certain. The four rate hikes that preceded today’s move are still working their way through the economy, given the long and variable lags with which monetary policy operates. Today’s increase adds to that restraint.
Housing is one area where that restraint is already becoming increasingly evident. The downturn is deepening and broadening, and we expect dwelling prices to fall by at least 12% from peak to trough, with the risk that the decline could be larger. The unemployment rate is also likely to continue rising, particularly as more people enter the labour force amid cost-of-living pressures, while household spending growth should weaken further.
There are, however, reasons why another rate rise cannot be completely ruled out. Services inflation has proven sticky and there has been relatively little disinflation in this part of the economy. Households in aggregate also retain sizeable financial buffers, which may need to thin further before monetary policy gains more traction. At the same time, the rapid build-out of data centres is supporting investment and activity, while uncertainty surrounding the Middle East conflict means energy prices remain an important upside risk to inflation.
The RBA’s new forecasts capture this increasingly difficult balancing act. Growth has been revised higher in the near term, partly because activity has proved more resilient than expected and data-centre investment has been particularly strong. But growth forecasts further out have been cut as higher interest rates, weaker housing conditions and higher energy costs weigh more heavily on the economy.
The labour-market outlook has also weakened. The RBA has lifted its unemployment forecasts and now expects the jobless rate to reach a little above 5% by the end of 2028. At the same time, its inflation forecasts have been revised materially higher. Headline and underlying inflation are now expected to remain above 3% until the end of 2027, with inflation not returning to the midpoint of the 2-3% target band until around mid 2028.
We are more pessimistic on economic growth than the RBA and expect unemployment to rise above 5% sooner and rise further than it is anticipating. We continue to include rate cuts in our forecasts for the second half of next year, but the RBA’s revised inflation profile makes the risk of rates remaining higher for longer difficult to ignore.
The timing of eventual rate cuts will depend heavily on the inflation trajectory. The RBA will need to be sufficiently confident that underlying inflation is moving sustainably back into the target band before it can begin easing. A sharper housing downturn would add to the case for earlier cuts, while an easing in Middle East tensions and associated energy-price pressures could accelerate the improvement in inflation. Conversely, persistent services inflation, stronger-than-expected domestic demand or another leg higher in energy prices could keep rates elevated for longer.
There is no doubt that the cash rate is a blunt instrument. While higher rates affect the whole economy, they do not affect everyone equally. Variable-rate mortgage holders feel the impact most directly through higher monthly repayments. But it is also important to remember why the RBA is raising rates. Inflation has remained above the 2-3% target band for an extended period and the cost-of-living impact is being felt much more broadly across the community.
Concerns about the outlook for growth are likely to increase following another rate rise. Higher rates will add to the headwinds already facing the economy and raise the risk of a sharper slowdown.
A recession is not our core view but the RBA is walking an increasingly fine tightrope. It needs to slow demand enough to bring inflation sustainably back to target without pushing an already weakening economy into a more serious downturn.
