Entrenched inflation leaves no room for patience

• • RBA raises rates for the third time this year
• • Energy shock collides with stubborn inflation
• • Inflation problem isn’t going away without a fight

Broadly speaking, the Board’s communications were on the hawkish side. In the May Statement on Monetary Policy, the Board reiterated that inflation had already picked up materially in the second half of 2025 and the Middle East conflict has added to this existing trend.

Unlike March, the Board’s decision to hike was not close (previously 5:4 split) with eight out of nine members voting in favour of the hike, with the Board’s updated forecast showing underlying inflation peaking higher and not expected to return to target until mid-2028. It was also acknowledged that, although financial conditions have tightened with prior hikes, credit availability remains strong, and the jobs market is healthy.

The Board had little scope to pause today as CPI continues its four-year trend well above target. Ongoing credit growth, now the fastest since 2022 when rates were well below 3%, supports the view that recent hikes might not yet be sufficiently restrictive. This is coupled with an economy with little capacity to absorb growth with any moderate demand increase likely to quickly transform into further inflation.

Conflating the challenges of pre-existing inflation for the RBA are the geopolitical ructions that are having direct and indirect impacts on the Australian economy.

The Middle East Crisis has once again highlighted the fragility of complex global supply chains. Countries such as Australia who have embraced global markets are discovering the uncomfortable reality that the assumption of cheap and accessible physical inputs were a luxury of a bygone geopolitical order.

As a direct example, Australia is the number one importer of diesel fuel in the world (see chart), an uncomfortable achievement for the 12th largest economy in the world.

The Australian economy is disproportionately exposed to downside growth risks, depending on the duration of the latest energy shock and potential ongoing structural change.

However, cost-push inflation doesn’t have the same impact as demand-pull inflation. Oil, gas and derivative prices going up will act as a tax on consumption with all the follow-on effects to growth and employment, which may limit transmission to inflation. The key question is whether the dominant effect of the Iran war is higher inflation or weaker growth. Looking forward, the RBA has good reason to be concerned about domestic growth, which will likely limit how high the cash rate reaches in 2026.

Martin Wilkinson

Head of Investments

[email protected]

Adam Downy

Senior Investment Associate

[email protected]

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