Australia poised to extend rate-rise pause as inflation cools

Australia’s central bank is set to extend a pause in interest-rate increases on Tuesday (May 2) following a deceleration in inflation that allows the board more time to assess the economic impact of its policy tightening to date.

The Reserve Bank of Australia (RBA) will keep its cash rate at 3.6 per cent for a second straight month, most economists predict and money market pricing shows. Deutsche Bank and Westpac Banking were among those that switched to hold from hike calls after first-quarter core inflation came in under forecasts. Commonwealth Bank of Australia stuck to its forecast for a quarter percentage-point move.

“We think the bar for restarting hikes is high and expect the central bank to remain on an extended pause,” Bank of America’s Izumi Devalier said in a research note, while predicting consumer prices will stay higher for longer. 

“The RBA’s preference for a soft landing implies reduced risks of a crash in growth and labour markets, making underlying inflation slow to come down.”

Australia is one of a number of Asia-Pacific nations, including South Korea and India, that have opted to stand pat. The region is likely to benefit from a reopened Chinese economy that is expected to drive global growth in the period ahead.

In contrast, the Federal Reserve and the European Central Bank (ECB) are both expected to push rates even higher this week. The Fed announces its decision on May 3 and the ECB a day later. 

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A key reason for the divergence is governor Philip Lowe’s desire to hold onto employment gains made during the pandemic. Unlike many developed-world counterparts, Lowe is willing to tolerate a “slightly slower return” of inflation to the RBA’s 2 per cent to 3 per cent target in order to deliver a soft landing for the economy.

“The RBA will probably maintain a tightening bias to keep pressure on inflation expectations. But our base case is that bias won’t translate into more hikes. In fact, forces are in motion that will likely prompt a policy reversal soon,” said Bloomberg economist James McIntyre.

The RBA says monetary policy is already restrictive in Australia, allowing it to monitor fallout from its 3.5 points of rate hikes since May 2022. Its scale of tightening is well below the US’s 4.75 and nearby New Zealand’s five points.

Australia’s economy has so far absorbed the rate rises reasonably well, with hiring persisting and unemployment hovering around a 50-year low. Still-strong job vacancies suggest the labour market will remain tight for some time yet. 

Business surveys point to ongoing resilience in the corporate sector while consumer spending – a key pillar of the economy – has also held up. It is likely to be buttressed by signs the property market has already found a floor.

For Lowe, these are positive outcomes; for some economists, they are compelling reasons to keep increasing borrowing costs.

“Every central bank would like to be able to stop tightening policy, but it’s probably still a little bit premature to completely call the peak” for the RBA rate, said Katie Dean, head of fixed income at AustralianSuper. She reckons Australia is at risk of seeing a breakout in wages. 

“I don’t think that market pricing, which is basically for the RBA to stay on hold for a fairly extended period of time, is likely,” she said. 

There are other arguments to tighten further.

Australia is experiencing a jump in population growth, currently running at about 2 per cent, compared with a pre-pandemic average of 1.5 per cent. That is already pushing up demand for housing, goods and services. 

Minutes of the RBA’s April meeting pointed out that the “sudden surge in population growth could be somewhat inflationary”.

The board on Tuesday will be presented with the RBA staff’s quarterly update of economic forecasts, which are unlikely to show an early return of inflation to target, particularly if policy remains unchanged for a period. 

Current estimates have headline inflation only hitting the top of the RBA’s target in mid-2025. 

While the updated figures and commentary will be published in full in the Statement on Monetary Policy on Friday, Lowe is likely to expand on the bank’s thinking in an evening speech in Perth following Tuesday’s board meeting. 

“No change to the RBA’s inflation profile would bolster the case to raise the cash rate,” said CBA’s head of Australia economics Gareth Aird. 

“It’s a very close call,” he said of the May decision. BLOOMBERG