Inflation certainty vs. global uncertainty

In a unanimous decision, the RBA’s Monetary Policy Board (MPB) cut the official cash rate by 25 bps to 3.85%.

The March-quarter CPI data and recent RBA forecasts have provided the Board with greater assurance that inflation will now stick in the target band over the medium term.

However, greater global economic uncertainty, sparked by unpredictable US tariff decisions, has the Board on high alert. The impact on Australia’s inflation is expected to be deflationary but domestic demand is expected to slow.

The RBA’s hawkishness on inflation has morphed into concern over domestic demand. However, the RBA is well positioned to take countermeasures, if needed.    

What the RBA’s Statement said

“With inflation expected to remain around target, the Board therefore judged that an easing in monetary policy at this meeting was appropriate. The Board assesses that this move will make monetary policy somewhat less restrictive. It nevertheless remains cautious about the outlook,”

“While recent announcements on tariffs have resulted in a rebound in financial market prices, there is still considerable uncertainty about the final scope of the tariffs and policy responses in other countries.”

“The Board considered a severe downside scenario and noted that monetary policy is well placed to respond decisively to international developments if they were to have material implications for activity and inflation in Australia.”

Statement by the Reserve Bank Board: Monetary Policy Decision, 20 May 2025.

https://www.rba.gov.au/media-releases/2025/mr-25-13.html

What the governor said at the press conference

“Price increases have slowed and it is fairly broadly based so this is good news.”

“Now since our last meeting, global economy and policy uncertainty has increased substantially following tariff announcements by the US administration, the response of its trading partners, and subsequent changes to the policies, including various bilateral trade agreements and deals - it has been a complete  rollercoaster I would have to say.”

“We see growth in our major trading partners slowing over the year and next year.”

“If you look at our scenario analysis, it does suggest that in a really bad outcome, there could possibly be a recession, yes, but that is in a very extreme circumstance.” 

“There isn’t a playbook for every circumstance but we have to be alert. So far so good.”

“Well if we continue to observe inflation come down and stay down sustainably, to the extent that we think there is restrictiveness in monetary policy, and we think there is a bit, then that will give us opportunities to lower the interest rate further.”

Inflation is looking good

The March-quarter CPI, released in late April, was a welcome salve for the Board's inflation concerns. CPI was flat at 2.4% but the RBA’s preferred measure, trimmed mean CPI, fell into the RBA’s target zone for the first time since 2021 (see chart below).

The Board is now confident that inflation and underlying inflation will stick to the target zone over the medium term. This can be seen in the decrease in the RBA's forecast for CPI in its May Statement of Monetary Policy (SMP) (see the dark blue column in the chart below).

While goods CPI ticked up a little in March to 1.3%, it is the continuing recent fall in services inflation that must be delighting the RBA. Services inflation decreased from 4.3% in the December quarter to 3.7% in the March quarter. Even more encouraging is that the fall is being driven by market-based services (see chart below).

Keeping the powder dry

Liberation day came and went and yet no one is the wiser as to the US’s aims and methods. The collateral damage from the uncertainty has been falling confidence around the world, less ships making the voyage from China to California, and deteriorating forecasts of global economic growth.

“The key point about the situation we’re in, is it’s not just that it’s uncertain, it’s actually unpredictable” Michele Bullock, RBA, governor, monetary policy press conference.

While the direct economic impact of new US tariffs on Australia will be minimal (see chart below) and the overall impact on inflation is expected to be deflationary, the indirect economic impact via China, our largest trading partner, is of concern. Iron ore being the focus of concern.

On the domestic front, unlike the US, consumer sentiment in Australia remains solid. However, the RBA is expecting consumer demand to fall over the year (see chart below).

The good news is that, with inflation under control and unemployment still low, the RBA has the monetary policy space to cut rates further over the coming year, if needed.

The little Aussie battler

It is also important not to forget the importance of Australia’s floating currency in absorbing shocks from the global economy. While exports may initially take a hit, a falling AUD against other major training partners (see the TWI in the chart below) will make Australian exports relatively more attractive.

Australian Private Debt Market

The Australian economy is in comparatively good shape despite global economic uncertainties. The RBA’s cautious approach has paid off and now it is in a good position to intervene with rate cuts as needed. Investors in the Australian private debt market will continue to benefit from the strong stability of the Australian economy even as waters elsewhere look less calm.