RBA May Meeting delivers another rate hike as anxiety about inflation and inflation expectations builds

Sally Auld | Group Chief Economist

Key points

• In an 8-1 decision, the RBA’s Monetary Policy Board elected to increase the cash rate by 25bp to 4.35%.
• After 75bp of hikes, the Board described the overall policy setting as “…well placed to respond to developments”.
• However, it also noted that risk to inflation and inflation expectations remain tilted to the upside. The risk of further tightening cannot be fully discounted.

Bottom line

The RBA Monetary Policy Board delivered a short Statement today, noting “…materially heightened uncertainties” about the outlook for both economic activity and inflation. The Statement expresses concern about the possibility of second-round impacts of higher oil prices and notes that short-term measures of inflation expectations have risen. The updated forecast set in the Statement on Monetary Policy now sees core inflation above the top of the 2-3% target band until mid-2027. This necessarily leaves the RBA with a hawkish bias, although with 75bp of hikes delivered thus far, the Board have delivered a reasonable recalibration to policy settings in so far this year.

Detail

In a relatively concise Statement, the RBA have outlined that the cumulative impact of greater capacity pressures in the domestic economy and the Middle East conflict have forced upward revisions of both headline and core inflation (peaking at 4.8% and 3.8%, respectively). 

This references the notion that the starting point for the Australian economy pre the conflict in the Middle East was an important driver of today’s decision – above trend GDP growth, elevated inflation and a tight labour market underscore the risk that second round price increases are both broad and rapid in their dissemination.

In the Statement of Monetary Policy, the RBA note: “Empirical modelling suggests that the effect of a supply-driven increase in fuel prices has historically flowed through to higher underlying inflation over one to two years. In the current episode, we judge that the pass-through of cost increases occurs relatively quickly – at the faster end of these empirical estimates – given that inflation and shorter term inflation expectations are already high and that the labour market is a little tight. The recent post-pandemic experience, in which costs rose sharply, may also prompt firms to raise prices more quickly than otherwise.”

Core inflation is not forecast to return into the target band until the second half of 2027. Just three months ago, this was expected by end 2026. This shift in the forecast trajectory for core CPI lends a hawkish bias to the RBA’s communications today, given that the assumptions underlying new forecasts expect oil to decline towards the low US$80s/bbl by the end of the year and for the cash rate to increase by a further 40bps or so.

Moreover, the RBA have expressed some concern about the level of short-run inflation expectations. Surveys of both households and businesses in recent months have shown a sharp rise in inflation expectations, which as noted above, will compound worries about the second-round price impact of higher oil prices.

The RBA Board went into the meeting facing upside risks to both inflation and unemployment. Today, the Board showed a clear preference to prioritise the price stability mandate. There is a strong message in this outcome, meaning that risks are biased towards a further adjustment in the cash rate. For now, we have the RBA on hold at 4.35%.

Unattributed votes

The Statement noted that today’s decision was 8-1 in favour of a 25bp increase to the cash rate. One Board member voted in favour of leaving the cash rate unchanged at 4.1%.

RBA staff forecast updates

The Statement’s baseline scenario forecasts slower growth and higher inflation, but only a modest upward revision to the unemployment rate track. The baseline forecasts assume the cash rate rises to 4.7% and the brent oil returns to around $82 a barrel in Q4 2026.

• Headline inflation is now seen peaking 0.6ppt higher than in February at 4.8%. at 4.0% over 2026 (from 3.6% in February). Trimmed men inflation peaks at 3.8% in Q2 and end the year at 3.5% (NAB forecasts are similar, 1 tenth higher at 3.9% and 3.6%). Underlying inflation returns to 2.6% over 2027 and 2.5% by mid 2028.
• Growth has been revised down to 1.3% over 2026 (from 1.8%) with growth also around 0.2ppt lower than previously forecast over 2027. NAB’s forecasts for GDP growth are marginally above the RBA’s, although we anticipate a much larger consumption slowdown than the RBA, whose downward revisions are driven largely by business investment and a larger drag from trade.
• The composition of the RBA’s growth revisions helps explain why there was an only small upward revision to the unemployment rate forecast. The RBA sees unemployment peaking at 4.7% in mid 2028, up only 1 tenth from their February forecast even with the higher cash rate assumption. That is a level they assess would reflect ‘a little spare capacity’.

The SoMP also included 2 adverse scenarios. These incorporate significantly higher energy prices but the same cash rate path. Both drive higher near-term inflation pressure. Adverse scenario 1 sees more persistent inflation pressure, while adverse scenario 2 sees a larger demand response limit inflation persistence. Notably, even in the adverse scenario with a larger pullback in demand, underlying inflation is only marginally below 2.5% in mid 2028.

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