RBA’s ‘confident’ 25bps rate cut – job done but uncertainties high
RBA cuts cash rate by 25bps as expected, policy still restrictive. Inflation now comfortably in the 2–3% target range with balanced risks.
As we expected and the market was pricing, the RBA cut the cash rate target by 25bps at its May Monetary Policy Board meeting. This brings the cash rate target to 3.85%, which the media release described as “somewhat less restrictive”, but nonetheless still at least a bit restrictive. The commentary at the media conference also showed a more dovish tone than what we heard in February and even April.
In the post-meeting statement and media conference, the Governor and Board noted that “underlying inflation is now expected to be around the midpoint of the 2–3 per cent range throughout much of the forecast period”. Inflation has tracked downwards broadly as both we and the RBA expected since the previous cut in February. Although the Governor expressed caution about using such shorter-run measures, it is noteworthy that trimmed mean inflation was already running at an annual rate of 2½% (the midpoint of the target) over the most recent two quarters.
In its April post-meeting statement, the Board said that it “needs to be confident that this progress [in getting inflation down] will continue so that inflation returns to the midpoint of the target band on a sustainable basis”. The further progress on inflation since then, in line with expectations, has allowed the rhetoric to shift to highlighting that inflation is now on target, and the policy challenge is to keep it there in the face of considerable uncertainty. In the media conference, the Governor described the moves as encouraging.
Indeed, with inflation inside the target range, and at its midpoint on some metrics, it would have been hard to construct a case to hold the cash rate unchanged at a clearly restrictive level. The domestic inflation story was, on its own, enough to warrant this rate cut, a fact acknowledged by the Governor in the media conference. Also, in the media conference, the Governor noted in response to a question that the case to hold was discussed but quickly dismissed.
At the same time, the RBA has no need to rush or to accelerate the pace of easing. At the new level of 3.85%, it is not that far from most estimates of the ‘neutral’ level that neither weighs on nor stimulates the economy; the RBA does not seem to have revised its estimate of neutral since February, judging by the material in the Statement on Monetary Policy (SMP). And while it is possible that it will end up needing to provide support to the economy with expansionary policy, rather than simply being less restrictive, we are not there yet. In the media conference, Governor Bullock highlighted that the Board has scope to move a lot should that be necessary.
Offshore risks were key in the RBA’s change of view. The current “roller-coaster” trade war is seen as weighing on both global and domestic growth. That said, one of the key judgements in the RBA’s forecasts is that, like Westpac, it assesses that the Chinese authorities have a “high appetite” to achieve the 5% growth target for 2025, and thus that the Chinese economy will slow only modestly. (The RBA’s forecast is just shy of the target at 4.8%.)
It is also noteworthy that the RBA now regards recent trade developments as disinflationary for Australia (as do we). Back in April, the Board said that “Inflation… could move in either direction” because of the trade war. The possibility of higher inflation is now said to arise only if the trade dispute induces significant supply-chain disruption – an outcome that looks less likely now following the recent US–China interim deal.
In the end, the inflation forecasts were only scaled back slightly, with the trimmed mean outlook shifting from flat at 2.7% to flat at 2.6% for the entire forecast period. The Board now describes this as underlying inflation returning to and remaining sustainably around the midpoint of the 2–3% target rate.
One area that the RBA had previously pointed to as a reason for not being confident that inflation can be sustained at current levels is the tightness of the labour market. While it still highlighted indicators that suggested remaining tightness, the forecasts for unemployment have been lifted slightly, while those for employment and wages growth have been reduced slightly.
Documents released under Freedom of Information show that, as at March this year, the RBA’s models were implying that the NAIRU was 4.69%, only marginally down from the 4.75% estimate these models produced at the time of the February 2025 SMP. This is noticeably above the average estimate of the market economists that the RBA itself polls, and slightly above the maximum estimate reported in its survey. The May SMP noted that its assessment of the location of full employment was unchanged, but both there and in the media conference, it was acknowledged that they could be overestimating the NAIRU and underestimating full employment. This contributed to some downward judgement in their inflation and wages growth forecasts.
While the staff are clearly grappling with the possibility they have been underestimating full employment, much of the analysis released in March centred on a ‘straw-man’ alternative hypothesis of a 4% NAIRU. Yet a NAIRU of 4¼% (in line with average estimate of market economists) would be enough to overturn the RBA’s concerns that the labour market is still too tight. Of course, the Governor would counter that they look at a broader range of metrics than just the unemployment rate relative to NAIRU estimates when assessing where the labour market is relative to full employment. In the end, though, their inflation models require a NAIRU estimate, so their inflation outlook hinges on the realism of those estimates.
The refreshed forecasts also significantly downgraded the RBA’s view on consumption. As we had previously highlighted, the RBA was well out of consensus in its bullish 2.6% forecast for growth in household consumption as at February. This was reduced to 1.9% in the current forecasts, though part of this is the near-term effect of Cyclone Alfred and there is some payback on the downgrade later on. In the media conference, Governor Bullock acknowledged that consumption growth had picked up more slowly than expected and that households were “being a little bit cautious” – a signal that has been evident for some time in Westpac’s Card Tracker and the Westpac–DataX Consumer Panel.
This month also marked the beginning of the RBA’s new system for implementing monetary policy. The media release accordingly no longer included an announcement of the exchange settlement funds rate, the rate that the RBA pays banks and others on deposits with the RBA.
Overall, this is a much less hawkish set of communication than February, or even April, and recalibrates the RBA away from its outlier view on the tightness of the domestic economy. We see no reason to adjust our view that the cash rate will be cut twice more this year (in August and November), taking it to 3.35% by year-end. This is contingent on underlying inflation trends remaining steady and no further downside shocks from abroad. As highlighted in the SMP scenario and in the Governor’s media conference, the Board has scope to cut further to support the economy should that become necessary.
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