Fast and Focussed

For a third consecutive meeting, the RBA raised interest rates by 25 bps. The cash rate is now at 4.35%. Eight members of the Monetary Policy Board voted for the 25 bps rise, while one voted to hold. 

The RBA has raised interest rates hard and fast so far this year. While it claims that it is focusing on the underlying domestic inflationary pressures and looking past the impact of the Iran war, it is clear that the war is also influencing its decision-making through rising consumer expectations. However, if the war continues for several more months, second-round effects from higher fuel and fertiliser prices will feed into general prices and will make the RBA’s work more difficult.

What the RBA’s statement said

“As expected, developments in the Middle East are having an impact on inflation. Higher fuel prices are adding to inflation, and there are indications that this is likely to have second-round effects on prices for goods and services more broadly. This inflation impulse is in addition to the high inflation recorded around the start of 2026, reflecting capacity pressures in the economy.”

“The Bank has updated its forecasts to incorporate recent data and developments in the Middle East. The baseline forecast, which assumes that the conflict is resolved soon and fuel prices decline, sees underlying inflation peaking higher than was expected in February. It then declines as demand growth slows and capacity pressures ease in response to higher interest rates.”

“A longer or more severe conflict could put further upward pressure on global energy prices; this would push up near-term inflation and could also increase inflation further out as these costs are passed through and if price rises get built into longer term inflation expectations.”

https://www.rba.gov.au/media-releases/2026/mr-26-12.html

What the governor said at the media conference

“Inflation in Australia was already too high before the recent conflict in the Middle East began.”

“The recent cash rate increases have been to address the excess demand that existed in the economy prior to the Middle East conflict. Higher fuel prices by themselves will not do this.”

“What these increases do, however, is to help to contain the domestic inflationary pressures after inflation due to oil and related commodity prices eases.”

“If left unchecked, higher costs get embedded into price and wage-setting decisions.”

“We’ve already seen expectations for inflation over the next year or so increase, and we need to ensure that this does not lead to higher expectations over the longer term. “

Addressing underlying inflationary pressures

In her media conference, RBA Governor Michele Bullock made it clear that the Board raised rates to address the underlying domestic inflation pressures. They are looking past the impact on inflation from the Iran war. From mid-last year, domestic demand has been stronger than expected and has outstripped aggregate supply.

The March inflation result showed a big jump in headline inflation, from 3.7% in February to 4.6% in March over the year. Automotive fuel was the second-largest contributor, with a 24.2% increase over the year. Electricity was the largest contributor, but this reflects the recent removal of government subsidies for households.

The RBA’s preferred measure for inflation, the trimmed mean, was flat at 3.3% in March (see chart below).

Bullock and the Board are right in saying that this 3.3% is what we should focus on and that this 3.3% is still too high and needs to be brought down. 

Finally, the cash rate is restrictive!

Of course, to address underlying inflation, the cash rate (and financial conditions‌) needs to be sufficiently restrictive.

Despite two consecutive rate rises and a split in the decision in March about whether a rate rise was needed so soon, the Board decided that another rate rise was needed now to ensure that the cash rate was sufficiently restrictive. Since late last year, the RBA has been saying that it was unsure if rates were restrictive or not! Now it is sure!

“At the moment, we are not certain how restrictive financial conditions are,” Michele Bullock, Media conference - monetary policy decision, 17 March 2026.

“The Board now judges that the level of the cash rate to be a bit restrictive. … This gives the Board space to see how the conflict plays out and the response of the Australian households and businesses to the shock.” Michele Bullock, Media conference - monetary policy decision, 5 May 2026.

The collapse of the narrow path

Just when the RBA has finally reached a sufficiently restrictive cash rate, the Iran war is weighing on inflation and growth. Preserving the employment gains since the end of the pandemic while wrestling inflation down (again) has just got a lot harder; the narrow path has become a razor.

“What the RBA has clearly done today … is to lean very much on the side of that path that is leaning over the precipice of recession to stay away from the fire of inflation.” Michael Janda, ABC News Business Editor.

Commentators debated at the start of the year whether a recession was needed to bring inflation back to target. But maybe it is no longer about the recession we have to have (to paraphrase former treasurer Paul Keating) but the recession that is being thrust upon us. In her media conference, Bullock said that fuel prices alone could not remove domestic inflationary pressure (through decreased spending), but they will surely ‌have an impact alongside the restrictive cash rate.

Keeping inflation expectations in check

However, besides keeping underlying domestic inflationary pressures under control, the RBA must also keep household and business inflation expectations in check. The RBA does not want inflation to become a runaway, self-fulfilling prophecy.

Inflation expectations have risen sharply with the rise in fuel prices and must have been a factor in the RBA raising rates again so soon (see chart below).

Source: Trading Economics

A focus on spending

The RBA will be razor focussed on consumer spending going forward. Will the now restrictive cash rate bring down domestic demand and thus domestic inflationary pressures?

The 1.6% monthly increase in March consumer spending suggests that the Australian consumer is so far unperturbed by the war when it comes to spending. Looking below the headline figure, while transport saw the largest increase in spending, five of the remaining eight categories also saw increases in March (see chart below). Further, discretionary spending increased from 0.5% in February to 0.6% in March on a monthly basis.

The RBA will hope that consumer spending will start to slow from April; otherwise, it may need to raise rates again, and a recession becomes more likely.

“When inflation is already too high, and the economy is facing capacity pressures, it doesn’t take much additional spending to make the job of returning inflation to target more challenging. This means spending will need to grow more slowly for a time to help restore the balance between demand and supply.” Michele Bullock.

Australian Private Debt Market

The Australian economy remains stubbornly strong despite interest rate rises and the war in Iran. However, the RBA will hope that its 75 bps in rate increases this year will soon slow the economy and thus inflation. It will also hope to preserve jobs, but the narrow path is narrowing. In the meantime, investors in Australian private debt can enjoy rising interest rates while they remain flat elsewhere (for now).