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Inflation Eases Only Gradually As Growth Stays Soft: Cash Rate Should Stay On Hold
Australia’s latest inflation figures are less severe than the March spike but remain inconsistent with the Reserve Bank’s 2–3% target band. The Consumer Price Index rose 0.6% in the June quarter and 4.0% over the year, compared with quarterly increases of 1.4% and 4.1%, respectively, in March. More concerningly, trimmed-mean inflation rose 0.8% in the quarter and 3.6% over the year, up from an annual rate of 3.5% in March. The complete monthly CPI produced a similar picture: headline inflation eased from 4.0% in May to 3.8% in June, but monthly trimmed-mean inflation remained at 3.6%. The decline in headline inflation owed much to automotive fuel prices, which fell 10.9% during June following lower world oil prices and temporary fuel-excise relief. Domestic price pressures remain considerably stronger: services inflation was 4.0%, non-tradables inflation 4.9%, housing inflation 6.8% and electricity prices 22.4% higher than a year earlier. Meanwhile, real GDP grew only 0.3% in the March quarter, although annual growth strengthened to 2.5%, while GDP per capita declined by 0.1%. The economy is therefore confronting persistent underlying inflation alongside subdued per-capita growth and a gradually softening labour market. Against this difficult economic backdrop, the RBA Shadow Board once again recommends the cash rate be kept on hold, attaching a 58% probability that this is the optimal decision.
Labour market data have become more volatile but, on balance, point to a gradual increase in spare capacity. Seasonally adjusted employment increased by 76,300 in June, comprising gains of 29,300 full-time and 47,000 part-time positions. The unemployment rate nevertheless remained at 4.4%, as the participation rate rose by 0.3 percentage points to 67.0%. Underemployment increased to 6.5%, while monthly hours worked rose by only 0.2%, to 2,014 million. Annual employment growth has slowed to 1.7%, well below the rates recorded during the post-pandemic recovery. Forward indicators are mixed. Job vacancies fell 2.1% in the three months to May and were also 2.1% lower than a year earlier, although ANZ-Indeed job advertisements increased by 0.8% in July and remained 2.1% higher over the year. Wage growth has moderated: the Wage Price Index rose 0.8% in the March quarter and 3.3% over the year, with new June-quarter data not due until after the Shadow Board round. The labour market is consequently no longer exceptionally tight, but employment growth and job advertising remain sufficiently resilient that a rapid retreat in labour-intensive services inflation cannot yet be assumed.
Australian financial markets continue to reflect persistent inflation risk, relatively firm commodity prices and uncertainty about the future path of monetary policy. The Australian dollar strengthened slightly above US$0.70 in early August. Government bond yields remain elevated. At the time of writing, the 1-year, 2-year and 5-year yields were clustered at approximately 4.5–4.6%, while the 10-year yield was just below 5.0%. The yield curve is therefore broadly flat across the short and intermediate maturities but noticeably upward-sloping further out. This configuration is more consistent with expectations that policy will remain restrictive for some time, together with a sizeable longer-term inflation and term premium, than with an imminent easing cycle. Equity prices have proved considerably more buoyant: the S&P/ASX 200 closed near 9,264 on 7 August, just below the record high reached in the previous session. Strong equity valuations and a firmer currency provide some tightening in financial conditions, but they also indicate that investors do not currently anticipate a severe domestic downturn.
Household indicators remain unusually divided between very weak confidence and reasonably firm spending. The Westpac–Melbourne Institute Consumer Sentiment Index rose 4.1% in July, from 80.6 to 83.9, but remained in the bottom decile of readings recorded over the survey’s 50-year history and well below the neutral level of 100. Expectations for family finances over the coming year improved markedly, while unemployment expectations declined, but households remained pessimistic about the broader economy and cautious about major purchases. At the same time, actual expenditure has been more resilient. Nominal household spending increased by 0.8% in June and by 6.0% over the year, following a revised 1.2% monthly increase in May, with particularly strong June increases in transport and recreation-related spending. Some of this strength reflects population growth, price increases and temporary purchases such as electric vehicles rather than a broad-based surge in real per-capita consumption. Nevertheless, the continued resilience of expenditure suggests that the transmission of higher interest rates to aggregate demand remains incomplete, even as households report considerable anxiety about inflation, mortgage costs and employment prospects.
Business surveys similarly depict an economy with weak confidence but ongoing activity. NAB business confidence fell nine points to -5 in June, while business conditions remained at +3 for a third consecutive month. Trading conditions were positive at +7 and the employment index remained marginally above zero, but profitability was flat, capital-expenditure intentions fell sharply and forward orders slipped back to zero. Measures of capacity utilisation have diverged markedly. NAB’s broader business survey reported utilisation of 82.0% in the June quarter, still slightly above its long-run average, whereas the Ai Group measure for Australian industry rose only marginally to 74.0% in July, after falling to 72.8% in June. The latter points to considerable spare capacity in industrial sectors. Encouragingly, NAB’s June Monthly Business Survey reported some moderation in cost and price pressures, with growth in labour costs, purchase costs and final prices slowing and retail price growth turning negative for the first time in seven years. More timely activity indicators were somewhat stronger: the Judo Bank/S&P Global flash PMI readings for July showed the composite index rising to 52.6 from 50.4, with services at 53.0 and manufacturing at 51.7. New domestic orders also improved, although export demand remained weak and firms continued to report pressure from wages, raw materials and fuel costs. Taken together, the NAB, Ai Group and PMI surveys suggest that private-sector activity has stabilised rather than contracted, but that conditions differ markedly across sectors. Weak confidence and investment intentions, together with substantial spare capacity in parts of industry, point to subdued momentum, even as broader business activity remains reasonably resilient.
The global outlook remains unusually vulnerable to geopolitical and energy-market developments. The IMF’s July World Economic Outlook Update projects global growth of 3.0% in 2026 and 3.4% in 2027, but it has revised its forecast for global headline inflation this year upwards to 4.7%. The baseline assumes that disruption through the Strait of Hormuz gradually recedes, with oil averaging approximately US$89 a barrel in 2026, yet the IMF warns that renewed escalation in the Middle East could lift energy and freight costs, raise inflation expectations, interrupt supply chains and tighten global financial conditions. The Fund also identifies a possible correction in highly valued technology-related assets as an important downside risk, while investment associated with artificial intelligence remains a potential source of stronger productivity and demand. The World Bank is more pessimistic, forecasting global growth of 2.5% in 2026 and average Brent prices of about US$94 a barrel; under a more severe disruption scenario, it estimates that world growth could fall to 1.3% and inflation rise to 4.4%. For Australia, higher energy and commodity prices provide some support to export income, but the benefits are uneven. Imported fuel, freight and production costs can raise domestic inflation, while weaker global activity, particularly in East Asia, would weigh on export volumes and business investment. The principal monetary-policy risk is therefore stagflationary: weaker external demand combined with another supply-side inflation impulse. First-round energy-price increases might become problematic because the present level of underlying inflation leaves less room to overlook any second-round effects on prices and wages through expectations.
The Shadow Board assigns a 58% probability that holding the overnight rate at 4.35% is optimal, a 7% probability that reducing the overnight rate to 4.10% is appropriate, and a 36% probability that raising the rate above 4.35% is called for. Accordingly, the mode recommendation is for a rate hold, but the Shadow Board’s perceived inflation risks remain on the upside and are growing.
Six months out, the Board attaches a 31% probability that the current cash rate is optimal, a 30% probability that the cash rate should be lower than the current setting of 4.35%, and a 40% probability that a higher rate is required. Once again, the mode is for the overnight right to remain unchanged. At the 12-month horizon, probabilities are 14% for a rate hold, 56% for a lower interest rate, and 31% for a higher rate, virtually unchanged from the last round. Three years out, the Board attaches a 75% probability of a lower rate being optimal, 8% to the current setting, and 17% to a higher rate.
The distribution for the current recommendation widened by 25 bps, ranging from 3.85%–5.35%. For the 6-month horizon, the distribution widened bimodally to 1.35%–5.60%. The distributions for the 12-month and 3-year horizons also widened slightly, to 0.85%–6.10% in both cases.
