May interest rate update
Key points
- The RBA reduced the cash rate by a quarter percentage point at its May meeting, as expected.
- The tone of their Statement focused more on the downside risks, with less concern about the inflation outlook.
- A hold on the current cash rate seems likely.
- My forecast for the low in the cash rate for this cycle is 3.1 per cent.
The RBA May meeting
The RBA reduced the cash rate by a quarter percentage point in its May meeting, as expected. It is unlikely that this will be the last cash rate reduction in this cycle.
The RBA expects that ‘underlying’ inflation will be around the mid-point of the target band over the next couple of years. Monetary policy is deemed to be ‘less restrictive’ (ie, it is still restrictive). The jobs market is strong, although consumer spending has been weaker than the RBA had anticipated. And US trade policy means there is identifiable downside risks.
The RBA has revised down their GDP forecasts this year, with weaker household spending playing a key role.
Business investment is expected to be lower both this calendar year and next. Public demand forecasts for next year have also been reduced. The RBA has revised up its view on dwelling construction activity. Hopefully that will be good news on the affordable housing front.
What this means for jobs and employment
Despite the strength of the jobs market, employment growth forecasts have been revised down and the unemployment rate up. This change would reflect the downward revision to economic growth. Both the underlying inflation and wages growth forecasts have been modestly revised downwards, consistent with the RBA becoming more comfortable with the inflation outlook.
My view on the economy and inflation
The past two quarterly Trimmed Mean CPI numbers showed that ‘underlying’ inflation was essentially at the RBA’s target of 2.5 per cent. That is consistent with consumer’s current inflation views and financial markets implied inflation projections.
Business inflation views currently suggests that inflation might be a little higher (2.5 to 3 per cent). The recent wages growth number came in stronger than expected although that was largely due to some big catch-up settlements in the public-sector.
Private-sector wages growth (more influenced by the state of the economy) is around 3.25 per cent consistent with the RBA’s inflation target.
The jobs market is in sound shape, with the unemployment rate low and jobs growth high. Labour shortages remain an issue and household concerns about unemployment are low. The pickup of approvals suggests that a turn in the residential construction cycle is under way.
Now, for the bad (or less good) news
The wider economy story is not as strong. Consumer spending is picking up as real household disposable incomes increase. But a fair chunk of the extra cash is being saved. The moderate pace of spending in the economy and above average cost growth is eating into firms’ operating profits leading to a cut in the size of capex budgets.
Population growth is slowing (although growth in the labour force remains strong). Fiscal policy will still be supportive of the economy. But the additional fiscal stimulus over the next couple of years is unlikely to be as strong as what has occurred over the past couple of years. And growth in the number of hours worked in the economy has been flat over the past four months.
And all of this is before considering the increase in US tariffs. It looks increasingly likely that the final level of tariffs will be well below what was announced on ‘Liberation Day’ but above the level prevalent at the start of the year. That is likely to result in slower global economic growth. But we won’t know what the final impact of higher tariffs will be for at least a couple of months (if we ever do).
Indeed, it is possible that uncertainty about US economic policy will remain a feature for the remainder of President Trump’s term. As there is uncertainty about the final size of tariffs countries don’t know how much additional support they need to provide their domestic economy.
The cash rate outlook
So inflation is about where the RBA wants it to be. Economic growth is picking up, and the labour market is strong. But economic growth is both currently below ‘normal’ and not as strong as the RBA (and most forecasters) had expected. The changes in US trade policy means the risks to the economic outlook are to the downside. Monetary policy is still considered restrictive.
My predictions
At the start of the year I was reasonably confident about a decent economic pickup and thought that 3.85 per cent could have been the bottom in this cash rate cycle. The thinking was that consumer spending would rebound in line with stronger income growth and there would be a strong investment cycle.
But the pickup in the economy this year has not been as strong as I had expected. Adding in the downside economic risk from the Trump tariffs means 2.85 to 3.35 per cent could be the cash rate floor (my updated cash rate forecast is 3.1 per cent).
At this stage, I expect the next quarter percentage point rate cut to be announced at the August meeting. At that meeting the RBA should have confirmation from the Q2 CPI number (released on 30 July) that inflation is at target.
I expect quarter percentage point rate reductions at the subsequent two meetings (September and November) as by then the negative economic consequences of the US tariffs should be evident in the economic data. A move earlier at the July meeting is possible if there is a run of weak domestic and/or global economic data.
At the time of writing financial markets had priced in an additional two quarter percentage point rate cuts before end-2025 (with a very good chance of a third), a view consistent with the consensus of financial market economists.
We really do live in interesting times.
Regards,
Peter Munckton
BOQ Chief Economist.
Want to hear more from Peter Munckton?
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