David Bassanese
3 minutes reading time
As I expected, the RBA delivered its 3rd consecutive rate hike for the year at the May policy meeting, citing upside inflation risks from both pre-existing local capacity pressures and the more recent Iran war-related energy price shock.
Although central banks often aim to “look through” the impact of short-run energy price shocks on the economy, the RBA is especially concerned that the latest shock is coming at an inopportune time of already tight labour and product markets. With both business and labour likely feeling they have good bargaining power, there’s a higher than usual risk that the energy price shock becomes embedded into inflation through a round-robin series of wage and price increases.
Indeed, as the RBA noted, “there are early signs that many firms experiencing cost pressures are looking to increase prices of their goods and services.” Elsewhere, the Bank noted that higher fuel prices are “likely to have second-round effects on prices for goods and services more broadly.” The RBA now expects annual trimmed mean inflation to peak at 3.8% in the June quarter before slowing to only 3.5% by the December quarter.
The RBA still expects annual trimmed mean inflation to reach the mid-point of the 2–3% target band by mid-2028, though this assumes a speedy resolution to the Iran war and a notable slowing in economic growth back to a below-trend pace. The RBA expects economic growth to slow from 2.6% over the course of 2025 to only 1.3% through this year, resulting in a 4.7% unemployment rate by mid-2028. Ominously, the RBA forecasts also assume the cash rate will “move in line with market expectations”, which currently incorporate one to two more rate hikes this year.
By contrast, my view is that if the RBA did deliver two further rate hikes this year, we’re likely facing a recession. Will that be needed? We can only hope not.
My base case is that the three rate hikes already delivered this year should be sufficient to take some of the wind from the economy, stemming the risks of an entrenched higher level of inflation. The three hikes – or HIKE trick – have completely unwound the rate cuts delivered last year, returning the cash rate to the 4.35% post-COVID peak level that succeeded in previously slowing the economy through 2023 and 2024. That should be enough.
At the least, the RBA seems likely to hold rates steady at the next policy meeting in June, allowing for some time to assess the economic impact of the rapid-fire rate hikes already delivered.