RBA hikes cash rate to 4.1% in a 5:4 vote. Perceived capacity pressures and inflationary impacts of the Middle East conflict were key concerns.
- As was widely expected, the RBA Monetary Policy Board (MPB) raised the cash rate 25bps to 4.1% following its March meeting. We flagged the possibility that it could be a split decision, but the 5:4 vote was an even finer majority than we thought might occur.
- The main reasons for the decision were the existing assessment that Australia is experiencing capacity pressures, coupled with the increase in inflation expectations that has already occurred in response to the Middle East conflict and associated spike in petrol prices.
- With the Board already split, a follow-up hike in May looks less certain. But (as revealed in the media conference) all members agreed that a hike was needed and the question was more about timing. We therefore retain a May hike as our base case. Whether the conflict in the Middle East is still ongoing and how it evolves from here will be crucial.
- The Board are also still concerned about domestic capacity pressures keeping inflation above target. This will mean rate hikes will remain on the table until inflation risks have clearly subsided.
Private sector demand growth was stronger than the RBA expected in late 2025, though consumption and unit labour costs were softer. The Board still assesses that part of the increase in inflation late last year reflected temporary factors. However, it is has taken signal from the recent strength in labour market data and now believes that capacity pressures are slightly greater than previously assessed. (This, incidentally, was the information value in the Deputy Governor’s podcast: that data revisions in the national accounts released earlier in the month did not dislodge the RBA’s view that trend growth in supply capacity is still only around 2%. It is well-understood that the internal Board members cannot front-run the whole Board, the way central banks with entirely internal members can.)
That “slightly” might point to one area where Board members’ views differ. Also noteworthy is the addition of the word “material” in a sentence that also appeared in the February post-meeting statement without that qualifier: “There are material uncertainties about the outlook for domestic economic activity and inflation and the extent to which monetary policy is restrictive.”
The other key reason for the decision centred on concerns about the inflationary impact of the Middle East conflict. The traditional thinking around the appropriate monetary response to a temporary supply shock such as a lift in oil prices was to look through it, so long as inflation expectations remained anchored. Near-term inflation expectations have already increased in response to the spike in fuel prices. However, the sparse evidence on more medium-term expectations of financial market participants suggests that these remain well-behaved, in Australia at least.
Yet the post-meeting statement highlighted the implications for (headline) inflation globally and domestically. In addition to the channel through inflation expectations, the post-meeting statement highlighted the possibility that an extended period of high energy prices and uncertainty would degrade supply capacity and thus be inflationary. Most other observers would see that scenario as a global recession risk with rather different policy implications. At the least, we struggle to imagine a scenario where the Strait of Hormuz remains closed for many months without sentiment and financial markets weakening considerably. The consequences for global growth in that scenario would be far from trivial, and not solely on the supply side.
It is possible that the RBA’s assessment of the implications of the Middle East conflict will evolve once it has done modelling of the impact. The Governor revealed in the media conference that the RBA staff have not yet done this modelling. In the meantime, Westpac Economics’ modelling and forecasts may provide a guide to possible outcomes.
The overall tone of the RBA’s post-meeting (and indeed pre-meeting) communication remains broadly as it was in February. The RBA remains concerned that the domestic economy is too tight and demand growing too quickly. As we have highlighted in the past, their assessment rests heavily on a view that the Australian economy can only grow around 2% before hitting capacity constraints. This view, in turn, rests on relatively pessimistic assumptions about population and productivity. While this remains the RBA’s view and inflation above target, rate hikes will remain on the table and our base case remains for a May rate hike.
