We now expect RBA to hike in June and August as well as May, given the longer Middle East conflict and early signs of strong second-round pass-through from fuel to other prices.
We have revised our view of the outlook for RBA policy, adding two further hikes to the near-term profile and pushing out the eventual reversal. We now expect 25bp rate hikes at the 16 June and 11 August decisions, in addition to the 25bp hike we already expected at the May meeting. The peak for the cash rate is now expected to be 4.85%.
This shift reflects the longer disruption to and slower recovery in fuel supply assumed in the revised baseline forecasts we first published on Friday afternoon, with the Strait of Hormuz essentially closed for eight weeks and traffic recovering only slowly after that. It also reflects the surprisingly rapid pass-through of higher fuel and other oil-derived product prices into other prices in Australia. We believe the RBA will respond to this pricing behaviour by tightening monetary policy by more than would have been needed absent that pass-through.
The halving of fuel excise, announced by national cabinet today, reduces the near-term outlook for headline CPI inflation, but a peak of 5.4%yr in June quarter remains likely. The announcement also does not affect prices of other oil-related products, including aviation fuel and various plastics, or any price increases from damage to gas and other production facilities in non-combatant Gulf states. Much of the second-round pass-through of prices is therefore likely to remain in place, and we continue to expect trimmed mean inflation to peak around 4%yr later this year.
The higher cash rate profile will weigh on Australia’s economic outlook. Growth will be slower, especially consumption, and the labour market will be softer. We expect unemployment to peak around 5%, somewhat higher than the 4.7% peak we flagged last week. Headline inflation will dip below 2½% by mid 2027 and will remain in the lower half of the 2–3% target range through to 2028. Trimmed mean inflation will take a little longer to decline, but will be back in the target range in 2028.
A companion note, also to be released this afternoon, fleshes out the rest of the forecasts. The revisions incorporate the assumed longer closure of the Strait of Hormuz and other supply disruptions in the Middle East flagged last week. In addition, we have updated for the new profile for the cash rate, the changes to fuel excise and some other recent events.
Despite the weaker economic outlook and potential undershoot of the inflation target implied by these revised forecasts, we think the RBA will be slow to reverse this policy tightening and risks getting behind the curve in coming years. We push out the date for rate cuts and pencil in four rate cuts, one per quarter in February, May, August and November 2028. We have low conviction about the exact timing.
The RBA will have already been spooked by the way inflation kicked up late last year after it took back some of its earlier rate hikes (though the usual lags of policy imply that the cuts were not the cause of that increase in inflation). We therefore suspect that the unwind of the current policy tightening will involve something of a “one bitten, twice shy” mentality. Second-round pass-through to other prices and costs will only increase the RBA’s reluctance to unwind the current policy tightening.
We also believe the RBA’s evolving intellectual framework will militate against an early reversal of these hikes. A supply shock such as the one the world is now facing should ordinarily be looked through to the extent possible, so long as longer-term inflation expectations remain anchored. Because it believes Australia is starting from a position of little spare capacity, though, the RBA sees the supply shocks as a potential reason to have both a restrictive stance of policy and to revise up its view of what constitutes restrictive policy.
The RBA has insisted that it retains its earlier strategy of holding onto as much of the post-pandemic employment gains as possible, subject to meeting the inflation target. While inflation was actually in the 2–3% target range for part of last year, underlying inflation did not get all the way back to the 2½% target midpoint before lifting again. This is clearly being interpreted in some quarters as inflation having been above target continuously. The Monetary Policy Board will therefore want to demonstrate its commitment to returning inflation back to target expeditiously and its willingness to do what it sees as necessary to achieve this.
As noted last week, there are risks on both sides of our revised baseline view. Iran is already letting some ships through the Strait, and it is possible that fuel supply recovers faster than we are currently assuming. It is also possible that a consensus forms domestically to resist second-round inflation, especially where the flow-on of higher costs to downstream prices could be construed as excessive. On the more inflationary side, it is possible that the war drags on longer, or domestic pass-through is stronger than we currently expect.
