Monetary Policy & Rates

The RBA held the cash rate steady this month following three consecutive 25bp increases to open the year, a unanimous decision that Governor Bullock paired with an acknowledgement the economy still carries "a bit of excess demand." We read the pause as genuine, not the end of the cycle. Our central case is that the Bank remains on hold through the second half of the year before delivering a further 25bp increase in the December quarter - a move we expect to be driven by cost-push inflation crystallising even as the broader economy looks lacklustre.

Underlying inflation is building beneath a softer headline

The case for a final hike is building beneath a softening headline. May headline inflation fell to 4.0% YoY, but almost entirely on a 12% fall in fuel and a 6.9% drop in travel prices; the trimmed mean rose to 3.6% YoY, the high of its series. The persistence sits in roughly a third of the basket and is supply- and cost-side in character: new dwelling construction is running at 5.6% YoY - its fastest since mid-2023 and adding some 42bps to headline inflation on its own - while rents are reaccelerating toward 4% and market services inflation remains broad-based. Critically, this is all evident before the Fair Work Commission's 4.75% award wage increase - which lifts pay for around a fifth of the workforce - takes effect on 1 July (the concurrent ~6% rise in the National Minimum Wage reaches under 1% of employees and is macroeconomically immaterial). We expect that award step-up to feed market services through the second half, with the late-October Q3 CPI the most likely trigger for the Bank to move.

A hike into a cooling economy

That this tightening would land into a cooling economy is, in our view, the defining feature of the outlook rather than a contradiction of it. The housing downturn has begun, hours worked softened in the month, and household spending is growing at its slowest pace in a year. Yet the labour market remains genuinely tight: unemployment fell back to 4.4% as April's spike reversed, employment rebounded 40k, and broader spare-capacity measures - underutilisation at 10.2%, underemployment near its cycle low - sit at generational tights. A central bank facing sticky, cost-driven inflation against a still-tight labour market has limited room to look through it, weak demand notwithstanding.

The 2027 risk: a wage-price spiral

Beyond the December move, we see a credible path to a second 25bp increase during 2027, though we treat it as conditional and sequenced. The first condition is that money supply growth remains strong, sustaining the monetary impulse behind demand; only if that holds does the second condition - a broadening in wages growth - become the mechanism that converts cost-push pressure into a self-reinforcing wage-price dynamic. Absent strong money supply growth, we would not expect wages alone to force the Bank's hand. We flag this as a risk case rather than our base but note it runs directly counter to prevailing assumptions of an easing cycle from late 2027. On our trajectory the next move is up, then held, and the eventual cut sits materially later than consensus.

Positioning

With the market pricing only around 8bps of tightening over the next twelve months, we regard the front end as under-pricing both the December hike and the medium-term risk profile. This is a higher-for-longer environment, and we continue to favour carry and income over duration, with elevated BBSW reflecting a rate path that has further to climb before it turns.