Clearer signs needed before another rate cut

By Grant Feng, Senior Economist

Markets and economy

The RBA wants to see a sustained reduction in inflation levels

Last week’s decision by the Reserve Bank of Australia (RBA) to keep its cash rate on hold at 3.60% came as no surprise.

Following the 0.25% interest rate cut in August, we believe further cuts will hinge on clearer signs of demand weakness and a sustained reduction in inflation.

After all, the economy is bouncing back strongly, the labour market remains on an even keel, and price pressures are proving somewhat stubborn.

However, given persistent labour market tightness and domestic demand recovery, the pace of further disinflation will be likely slow.

Additionally, the peak of tariffs uncertainty is largely behind us, albeit it is still elevated, and the global economy remains resilient.

Taken together, both domestic and international developments support a cautious policy stance.

Our baseline view is still that the RBA will deliver one more 0.25% cut before the end of this year, leading to a year-end cash rate of 3.35%.

However, the upside surprise from the August Consumer Price Index (CPI) inflation reading, alongside a firming Australian economic recovery, raises the risk of a rate pause in the last quarter.

The third-quarter CPI print, which is due for release on October 29, is likely to influence the RBA’s future rate decisions.

Key takeaways

On the domestic front, recent economic data has surprised to the upside. The August headline CPI inflation rate came in at 3.0% year-on-year, while trimmed mean inflation eased to 2.6% from 2.7% year-on-year. Household spending remains robust, and the labour market continues to exhibit tightness, with the unemployment rate over recent months remaining remarkably steady and close to the RBA’s forecast. Combined with weak productivity growth, this tight labour market is contributing to elevated unit labour costs, which will slow the pace of disinflation.
On the external front, along with more trade deals between the U.S. and other trade partners coming through, most global growth indicators remain relatively resilient. Global Purchasing Managers’ Indexes remain in expansionary territory, and global goods trade is still rising solidly, while commodity prices are holding up. We believe the direct impact of U.S. trade policy on Australia’s economy is likely to be limited due to relatively modest bilateral trade volumes and the flexibility of Australia’s commodity exports across global markets.
In light of the slow pace of disinflation, the tight labour market and growth recovery, the RBA’s decision to pause further rate cuts is well founded. We continue to expect the disinflation process in Australia to be slow and uneven. Accordingly, the RBA is likely to maintain a cautious stance, with any future easing expected to proceed at a measured pace over the remainder of the year.

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