Further interest rate cuts likely as RBA confident it's won the inflation fight

The Reserve Bank has cut interest rates amid greater confidence that the inflation battle is won, and will remain won, even if borrowing rates fall further from here.

Forecasts in the RBA’s latest quarterly Statement on Monetary Policy (SMP) offer good news for borrowers, by suggesting that market pricing for a 3.2 per cent cash rate by early next year is compatible with inflation staying near the middle of its 2-3 per cent target range.

At 3.2 per cent, the trough in the cash rate would be 1.15 percentage points below its post-COVID peak of 4.35 per cent, implying at least two standard-sized 25-basis-point rate cuts ahead, with the possibility of a third or an outsized rate cut of 35 or 50 basis points.

Each quarter-of-a-percentage-point rate cut is worth $76 a month to someone with a $500,000 mortgage.

Falling oil prices, tame wages help inflation outlook

Highlighting how much the bank’s outlook on inflation has softened since its last forecasts in February, markets have priced in an additional 30 basis points of rate cuts, yet the RBA’s forecasts based on this market pricing have its preferred measure of core inflation sitting slightly lower at 2.6 per cent over the two-year forecast period.

It’s forecasts for headline inflation in the short-term have been slashed by 0.3 of a percentage point to 2.1 per cent for the year to June, and by 0.7 of a percentage point for the year to December.

The former is mainly due to a recent drop in oil prices of more than $US10 a barrel relative to February’s forecasts, while the latter is also assisted by the government’s plan to further extend electricity price rebates.

However, the slight decline in the less volatile “trimmed mean” inflation measure indicates that the RBA’s economists expect this inflation reduction to be sustained.

Despite some media commentary about a slight uptick in annual wages growth in ABS data released last week, the RBA actually slightly lowered its expectations for wage growth in its latest forecasts.

Combined with a slight upgrade in labour productivity forecasts, it hints that the bank is becoming more comfortable that the level of wages growth is compatible with both further rate cuts and inflation returning to target and staying there.

Trump’s tariffs lead to global growth downgrade

Donald Trump’s “Liberation Day” tariffs are the key factor behind a 0.5 percentage point downgrade to economic growth forecasts for Australia’s major trading partners this calendar year.

That and a softer-than-expected recovery in household spending, partly due to the uncertainty created by the Trump administration’s unpredictable policy turns, are the key factors pulling down the GDP growth forecast for Australia’s economy by 0.3 of a percentage point to 2.1 per cent for 2025.

Ahead of the rates decision, Westpac chief economist Luci Ellis told The Business that she expected the RBA would be forced to lower its household spending forecasts.

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“The RBA is well out of consensus in terms of its February forecasts about consumption growth,” said the former RBA assistant governor for economics.

“So at Westpac economics, we’re expecting household to consumption to increase about 1.5 per cent over calendar 2025, and that’s the sort of the median of all the market forecasters. The February forecast from the RBA was 2.6.

“They’re very bullish about the tendency for people to pick up their spending, but that’s not what we’re seeing in our own Westpac DataX data. It’s not what we’re seeing in the ABS data.”

The RBA has now lowered its 2025 forecast for household consumption to grow by 1.9 per cent.

The bank has also sounded a warning around one of the key risks if US economic policy making remains unpredictable and an increasing number of investors lose faith in the US government and the economy it oversees.

“Given the key role that US dollar assets, and particularly US Treasuries, play in global funding markets and the management of market participants’ credit and liquidity risks, any lasting shift in investor behaviour towards US assets could increase the risks to market functioning or financial stability in the event of another similar negative shock,” the bank noted in its SMP.

However, the Reserve Bank currently expects a mildly disinflationary effect for Australia from the US tariffs as exporters, especially in China, seek to redirect their manufactured products to lower tariff markets, potentially increasing supply and reducing the prices of many imported goods.

However, it modelled the effects of a so-called severe scenario, where tariff rates revert to Liberation Day levels, and noted that it could slash rates quickly in response if necessary.

“The Board assesses that this move will make monetary policy somewhat less restrictive. It nevertheless remains cautious about the outlook, particularly given the heightened level of uncertainty about both aggregate demand and supply,” the RBA board’s post-meeting statement noted.

Home building, not prices, expected to take off

The RBA has also become more upbeat about the prospect of Australia addressing its apparent housing shortfall, considerably upgrading its forecasts for dwelling investment.

In the near term, this is largely due to already planned developments starting construction, however by next year the RBA expects the effects of falling interest rates and government policies to boost housing supply to be taking effect.

The RBA noted that early indications since its rate cut in February suggest that house prices have “yet to materially respond to easier borrowing conditions”.

If this continues, it will be another factor giving the Reserve Bank board more confidence to lower rates further.

Dr Ellis forecast Tuesday’s 25-basis-point rate cut, saying it would be problematic if the RBA left interest rates too high for too long.

“We’ve got to remember that monetary policy does operate with a lag and so you know the decision they make tomorrow is going to have its peak effect on inflation next year,” she said.

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