The RBA lifted the cash rate by a further 25 basis points today, taking it to 4.35%. This marks the third consecutive rate increase and returns the rate to the peak reached in the previous tightening cycle. The decision aligned with our forecasts and market consensus and the 8–1 vote signalled a more decisive outcome than in March.
Inflation was already uncomfortably high before the war in Iran and price pressures have only intensified since. Headline inflation rose in the March quarter to a 2½-year high of 4.1% in annual terms, while underlying inflation increased to 3.5%. Both outcomes sit well above the midpoint of the 2 to 3% inflation target band. More concerning is the shift in inflation psychology. Short-term measures of inflation expectations have moved higher and price increases are already occurring with more firms preparing to lift prices as cost pressures persist. Left unchecked, this behaviour would make inflation even harder to bring down.
Three consecutive moves matter. After a rapid sequence of increases, the RBA may choose to leave policy unchanged at its June meeting to assess the war and how tighter financial conditions are working through the economy. Our view remains a June pause followed by another rate increase in August, although a move in June cannot be entirely ruled out. In the press conference, Governor Bullock described the current level of the cash rate as “a bit restrictive” and said it places the Board in a “good space” to consider risks on both sides. That language points to the Board taking stock in June and aligns with our existing forecasts.
Swap markets are currently also pricing in a pause with the next rate hike fully priced in September and a partial probability of nearly 35% before the end of the year.
The Governor also made it clear that these rate increases will not materially affect inflation over the next six months. Much of the near term lift in inflation is already baked in. The RBA’s baseline forecasts point to headline and underlying inflation rising further and peaking at 4.8% and 3.8%, respectively, in the June quarter. Our own forecasts sit a bit higher, at 5.2% and 4.0%, respectively.
What matters next is how demand responds. Timely consumer-spending data suggest the adjustment still has a way to go. Despite sharp falls in consumer sentiment and weaker business confidence, household consumption has yet to slow in a meaningful way. The gap between confidence and spending points to a slower transmission of higher interest rates into demand than the RBA would prefer, supporting our view that the cash rate has not yet peaked.
The inflation outlook continues to be incredibly complicated by global developments. Uncertainty around the duration and severity of the conflict in the Middle East has increased the range of possible outcomes for inflation and growth. And it has made the trade-off between growth and inflation much worse for the RBA.
The RBA’s quarterly Statement on Monetary Policy notes that businesses widely report they are actively considering price increases should cost pressures persist or broaden. Downstream impacts have been most evident in construction and property development, where transport and oil derived materials account for a large share of total costs. Fuel surcharges and price escalation clauses are increasingly being triggered on existing civil and commercial projects, while new projects are being priced on the basis of higher assumed costs.
The RBA continues to carry a dual mandate of maintaining price stability by keeping inflation low and stable over time, while also supporting full employment in the Australian economy. On labour market conditions, the RBA continues to judge labour market conditions as “somewhat tight”, little changed from earlier this year.
Forecasts
The updated forecasts underline the policy challenge ahead. GDP growth has been revised lower across the forecast horizon through to the June quarter 2028. Growth is expected to slow to 1.3% by the end of this year, close to our own existing forecasts, before picking up only modestly in late 2027. Bullock described this growth profile as “anaemic”.
The unemployment rate is now expected to rise more than previously forecast, although only gradually and from later this year. Our view remains that unemployment will be higher than the RBA anticipates by the end of 2026. A slowdown in hiring should do most of the work early, rather than a sharp lift in layoffs.
Underlying inflation, the RBA’s primary focus, has been revised higher this year and into the first half of 2027. Inflation is expected to move back toward the midpoint sooner, but the return to the target band has been pushed out to 2027. These forecasts remain broadly consistent with our expectation that rate cuts could begin from the September quarter of 2027. However, uncertainty is unusually high, increasing the degree of variability around the outlook. There is still a great deal of water to flow under the bridge before then.
*The inspiration for the heading comes from Wagga Wagga, which hosted its famous race day on Friday and welcomed a lively contingent of Sydney school mums over the weekend. Facing a long wait for an Uber at the airport, two locals, Joanna and Anthony, who were complete strangers to me, insisted on driving me the 20 kilometres to my venue. It was a small moment, but one that stays with you and reminds us of the kindness and generosity of spirit carried by Australians, especially in regional Australia.
