May Hike Driven By Upside Risks To Inflation, Watch Q2 Services CPI

The RBA minutes show that the decision to hike rates 25bp in May was “finely balanced” and that both a pause and 25bp were discussed. What tipped them back to tightening seems to be upside risks to inflation outweighing downside risks, given their “strong commitment to price stability”. The rate outlook seems highly dependent on services inflation developments, as they are domestically and wage driven. Q2 CPI is released on July 26, making the August meeting the most likely for another move.

• The tone seems to suggest that there is some concern on the Board that the inflation target won’t be achieved by mid-2025 and that there was “little room for upside surprises to inflation” given that it would be above target for four years. The forecast also included one more rate hike. But there remain “significant uncertainties”.
• The minutes were focussed on inflation. Given “little room” for an upside inflation surprise, the Board discussed the chance of that happening. They noted current rising Australian and sticky overseas services inflation. There is also the risk that prolonged elevated inflation will result in higher inflation expectations. The impact of strong population growth on already tight rents was cited as well. It noted that the “labour market remains tight and that inflationary pressures were significant”.
• For inflation to return to target by mid-2025, the RBA has assumed that productivity growth returns to its pre-pandemic rate. There is definitely a risk that it won’t given its current low level and that it is unlikely the federal government will implement any of the Productivity Commission’s recommendations. Thus, there’s a high chance that “unit labour costs would be uncomfortably fast”.
• The Board also observed that its decision to pause had contributed to a weaker AUD and higher house prices, which adds to inflation risks.
• The discussion around a second pause was based on the downside risks to inflation – that it was slowing, wages consistent with target, possible weaker-than-expected consumption, mortgage refis to higher rates and higher unemployment putting greater downward pressure on inflation.
• See minutes here.