RBA hikes as expected in 8–1 vote, citing Middle East boost to existing inflation pressures. Further hikes this year remain likely but June timing is more finely balanced now.
As expected, the RBA Monetary Policy Board (MPB) raised the cash rate 25bps to 4.35% following its May 2026 meeting. The vote was again split, this time 8–1, after the 5–4 vote in March. In explaining the decision, the MPB cited the higher inflation stemming from the Middle East conflict, including second-round effects, with risks tilted to the upside. These added to the inflationary pressures already arising from what it sees as capacity pressures. It also noted indications that “higher fuel prices are likely to have second-round effects on prices for goods and services more broadly”, as we have been highlighting.
While the MPB regards monetary policy as mildly restrictive, both the Statement on Monetary Policy (SMP) and the Governor pointed to credit growth and other indicators as suggesting that financial conditions are not as tight for the same level of the cash rate as was true a few years ago.
We still expect the RBA to tighten rates again this year. However, we think a June move now looks more finely balanced. The Governor’s language in the press conference was a bit more dovish than our read of the media release and the SMP or the implications of the RBA staff forecasts. Governor Bullock characterised the three rate hikes so far as dealing with the high inflation issue that already existed before the conflict in the Middle East started, and that this “gives space” for the MPB to see how the conflict played out. On a plain reading, this might suggest that the MPB is more inclined to pause in June.
The RBA’s inflation forecasts show trimmed mean inflation peaking in Q2 at 3.8% and moderating a little from there but only getting back to the 2.5% target midpoint by June 2028. Contrary to the Governor’s remarks, this implies that the MPB is comfortable with the idea of following something like the market path from here, which at the time the forecasts were finalised implied one-and-a-half more hikes. This forecast is also based on a futures market path for oil tracking back to USD80/bbl by year-end, which might be too optimistic.
Our own assessment, however, is that there is a bit more near-term inflation to come, both from a higher oil price than future markets imply and greater, more drawn-out second-stage pass-through to other prices, especially in areas such as home-building costs. We therefore think the near-term inflation risks are tilted to the upside relative to the RBA forecasts. Our own inflation forecasts see trimmed mean inflation peaking at 4% and staying there for the remainder of 2026.
The question is what might happen between now and the June meeting that would dislodge their view about the outlook. While there are several key events, including the Federal budget and National Wage Case decision, these are unlikely to turn the dial on the RBA forecasts. Meanwhile, the inflation expectations story is going to be hard to monitor in the near term.
We were surprised that the Governor appeared to give the green light to firms passing these fuel and fertiliser cost increases into their own prices, saying that it is reasonable for them to do so. This stood in contrast to the discussion in the media conference about avoiding pass-through to wages. At several points, the Governor emphasised that the energy price shock “makes us all poorer” and there was nothing that could be done about that. In our view, it would have been more helpful to the RBA’s own inflation fight if the Governor had encouraged firms that had the capacity to absorb those cost increases to do so.
Consistent with the track for both inflation and interest rates, the revised forecasts are for lower growth in GDP and consumption, with business investment softening later this year as well. The labour market softens with a lag, though we note that both the solid near-term forecasts for hours worked and the forecast decline in participation further out are fragile.
The SMP included some forecast scenarios centred on higher outcomes for oil prices. These were qualitatively similar to the scenarios we have been publishing and revising since 3 March, though the decline in inflation in their scenarios is relatively front-loaded.
There are a number of tensions in the RBA’s forecast revisions. Although measures of labour market slack, especially underemployment, have been revised up, so was the Wage Price Index, marginally. The RBA assesses that a little spare capacity will open up in the labour market, but not until 2028. A lot hangs on a relatively downbeat government forecast for population growth and an assumption that the participation rate cyclically declines, against the upward trend that has persisted for decades.
Similarly, the near-term forecast for productivity growth is quite downbeat. With actual productivity growth at 0.9%yr for 2025, the forecast of 0%yr to June quarter 2026 implies quite a turnaround, particularly for hours worked. While measured productivity growth is cyclical, this may induce the RBA to remain pessimistic about the underlying trend.
