Economic Update - May 2026

The war in the Middle East continues to play havoc with global inflation, bond yields, and growth. After three-consecutive rate rises, the RBA will likely keep rates on hold next month. Meanwhile, the US is moving from a position of a possible rate cut to a possible rate rise. However, we are yet to understand how Chairman Warsh's stance will differ to public and presidential expectations.

What happened in Australia?

For the third-consecutive meeting, the RBA raised interest rates by 25 bps. However, unlike the 5-4 split vote in March, the May meeting was a clear 8-1. The hot March inflation result and rising inflation expectations against the backdrop of underlying domestic inflation pressures were too much for the RBA to ignore. Price pressures from the Middle East war do not help either.

Given that the RBA finally believes that interest rates are now ‌restrictive, it is likely to hold rates at the June meeting.

“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.

Subsequent employment, inflation, and wage-price data released during the month further support the case for a rate pause.

Unemployment increased from 4.3% in March to 4.5% in April. Headline inflation decreased from 4.6% to 4.2% while the RBA’s preferred inflation measure, the trimmed mean, increased only slightly from 3.3% to 3.4% (see chart below). The wage-price index fell from 3.4% to 3.3%.

The federal government’s cut to fuel taxes and its diplomatic efforts to secure fuel supply have contributed to lower fuel prices and lower inflation in April. This can be seen in the monthly decrease in transport inflation below.

The RBA will be keen to see the March-quarter GDP figures when they are released in early June. The RBA will hope that its interest rate medicine is calming domestic inflationary pressures.  

May is budget month. Most budgets come and go quietly, but as expected, this budget still has people talking. The government drew on its political capital to unveil several bold policies focused on removing excessive investment incentives for housing. It removed negative gearing for investment properties and reduced the capital gains tax discount for investments held for over 12 months. With the share of home ownership among the young falling over several decades (see chart below), the government wants to make housing more of a home and less of an investment.

Most economists have applauded the proposed changes, but the younger generation is yet to be convinced. They ‌watched the baby boomers build wealth through property and were ready to do the same. Now they will have to adjust.

Small businesses and startups are wary of changes to the capital gains tax and tighter taxes for trusts. The government is willing to talk and is most likely to expand existing exceptions for startups.

What happened around the world?

USA

Kevin Warsh has entered the Federal Reserve building in Washington. Most commentators expect a more dovish chair than Jerome Powell, albeit one who dislikes quantitative easing. However, since taking office, Warsh has offered few words. Even his photo on the Federal Reserve website is not forthcoming (see screenshot below). Which way will Warsh go?

Taking over as Fed Chair is never easy, and it is certainly not easy at the moment.

The US labour market is showing some strength with a second month of non-farm payrolls over 100k (see chart below).

Further, inflation and the Fed’s preferred inflation measure, PCE, are rising again as the Middle East war pushes up fuel prices (see chart below).

Inflation expectations are also rising and helped push US 30-year treasury yields to a 19-year high in the middle of the month, before falling oil prices saw yields fall (see second chart below).

The President may hope for several rate cuts soon, but the market doesn’t see one in June nor anytime soon (see chart below). Meanwhile, the small number of commentators arguing for a rate rise are getting louder.

Source: CME FedWatch Tool

China

Chinese exports beat forecasts and rebounded by 14.1% in April. However, news over the rest of the month was mostly dour.

The official manufacturing PMI fell in May, with export demand weakening more than domestic demand (see chart below). The Producer Price Index increased again (see second chart below), so Chinese factories are feeling pressure from weakening demand and rising prices. The war in the Middle East is biting.

Retail spending fell from 1.7% in March to 0.2% in April over the year. The market had expected a 2% rise. And on top of this, government spending fell 7.3% in April, driving down fixed investment (see chart below).

Source: CNBC

EU

Euro area inflation increased from 3% in April to 3.2% in May, with energy costs the main driver (see chart below).

Euro area exports fell for the third-consecutive month in March (see chart below) with EU exports to the area’s largest trade partner, the US, down 37.1% over the year. Tariffs are playing havoc!

Japan

March-quarter GDP grew faster than expected at 2.1% (see chart below). Other economic data also point to a possible rate rise when the BoJ meets in June: exports increased 14.8% in April on the back of strong semi-conductor demand and spring wage bargaining continued the trend of 5%-plus wage growth (see second chart below).

A higher interest rate should help the BoJ keep a weakening yen higher against the USD. Over the last three months, the yen has reached the key 160 level several times.

UK

After meek recent growth, GDP grew 0.6% in the March quarter compared to the December quarter (see chart below). Inflation decreased from 3.3% in March to 2.8% in April: a large increase in fuel costs was counteracted by a decrease in housing and housing services. These strong results reward the BoE’s recent reluctance to raise interest rates.

Source: ONS

New Zealand

Th RBNZ kept rates on hold at its May meeting. The Middle East war is putting pressure on inflation and growth just as the economy was recovering from the doldrums of last year.

“We don’t expect a recession right now. Rather, the view is that the Iran war will merely cause a pause in the economic recovery.” Westpac IQ, NZ Economic Overview May 2026.

What this means for Australian Private Debt

Three interest rate rises may be the required medicine for Australia, but the upcoming March-quarter GDP result, followed by further inflation and employment figures, will provide a better diagnosis for the RBA. So far, so good, given the circumstances.