The central bank has signalled it still has a tightening bias on above-target inflation and tight labour market conditions
The Reserve Bank of Australia (RBA) kept the cash rate on hold at 4.35% in August, the second meeting in a row that it has not lifted the policy rate (following three consecutive hikes between February and May). This decision was in line with consensus expectations, following the softer than anticipated June inflation outcome.
This hold will come as a relief to mortgage holders and potential buyers. For a buyer taking on the average new owner-occupier mortgage of $735,000 in the March quarter, the three rate rises this year lifted their repayment by just over $350 a month. For a household earning the median income, borrowing capacity fell by 7.0%, or over $53,000 following these hikes.
While most economists believe that the cash rate has peaked, this is not a foregone conclusion. Comments in late July from Reserve Bank Governor Michelle Bullock revealed that the Monetary Policy Board retains a tightening bias, reflecting underlying inflation that has remained persistently above target and a labour market that has proved to be resilient.
Headline inflation was softer in June, down to 3.8% (from a recent peak of 4.2% in April). However, there has been plenty of volatility in underlying components in recent months, including discounts to the Federal Government’s fuel excise and the impact of free or discounted public transport in a range of cities. The RBA’s preferred measure of inflation, the trimmed mean, was stable in June at 3.6%.
These distortions, combined with lags in the data, mean it is not yet clear whether inflation has peaked yet. Uncertainty around the flow of oil from the Middle East continues to impact energy prices here in Australia, while the CPI measure of rent has tracked sideways in recent months, lagging behind the increases Cotality have observed in our data. There are other inflationary pressures in the housing sector as well, including higher construction costs lifting the price of new homes.
Labour market conditions also remain uncomfortably tight for the Reserve Bank. Seasonally adjusted unemployment was unchanged at 4.4% in June. Looking through the month-to-month volatility, unemployment has essentially tracked sideways since mid-2025 and remains historically low. The RBA would like to see greater slack in the labour market to reduce inflationary pressure via competition for labour bidding up wages.
While the big 4 bank economics teams are expecting the RBA will now remain on hold for an extended period, the tightening bias means that the near-term risk is another hike if inflation surprises to the upside in coming months. Interbank futures market pricing suggests a 60% possibility of another rate rise by March 2027, but this is well down from where things sat coming out of the May RBA meeting (where two further increases were almost fully priced in).
If instead this is the peak of the current rate cycle, it is unlikely that the Reserve Bank will start cutting rates until well into 2027. The earliest rate cuts forecast by the big 4 banks are May (CBA) and June (NAB), with the others looking to the second half of 2027. From a housing market perspective, current restrictive interest rates have been a key contributor to the demand-driven downturn in home values over the past four months, and a recovery in the market is unlikely before households have some certainty that a rate cutting cycle is imminent.
