At the start of last week, speculation swirled about a potential Reserve Bank rate hike. However, that talk has cooled, even though RBA Governor Michele Bullock noted that a hike remains an option following the board’s meeting on Tuesday.
Meanwhile, in the U.S., discussions are now focused on a potential double rate cut—two standard-sized reductions at once—aimed at preventing a recession when the Federal Reserve meets next month. Markets there are pricing in five standard cuts over the next four months.
In Australia, the case for further rate hikes has weakened, with inflation concerns no longer as pressing. This shift has undercut one of the key arguments for increasing rates this year.
Despite Governor Bullock’s comments on keeping all options open, many analysts believe interest rates may need to come down sooner than the RBA currently suggests.
Inflation Set to Drop, Rebound, and Drop Again
After holding the cash rate steady at 4.35% this month, the Reserve Bank announced updated forecasts.
The bank now anticipates that inflation will return to its target band by Christmas.
Australia’s inflation rate started the year at 4.1%, dropped to 3.6% in March, rose slightly to 3.8% in June, and is expected to reach 3% by December—right on the edge of the RBA’s 2-3% target range.
A significant portion of the projected decline in inflation will result from two measures introduced in May’s federal budget: a $300 energy price relief per household and a 10% increase in Commonwealth Rent Assistance.
According to the Reserve Bank, these measures will collectively reduce measured inflation by 0.60 percentage points.
However, once the energy price relief expires in mid-2025, inflation is expected to temporarily rise above the target range before trending back down from late 2025.
The Reserve Bank also anticipates that its preferred gauge of underlying inflation, the “trimmed mean,” will continue its downward trend, as it has since late 2022.
The Risks of Delaying Action
Interest rate changes take time to ripple through the economy—typically up to a year, and sometimes as long as two years.
The Reserve Bank considers the current rate level “restrictive,” meaning it’s curbing spending and price growth. If the Bank keeps rates unchanged until inflation fully settles within the target range, it risks overshooting, pushing inflation too low and unnecessarily harming the economy.
At Tuesday’s press conference, Governor Michele Bullock acknowledged that her message of no immediate rate cuts was at odds with market expectations and “not what people want to hear.”
However, market sentiment has gained momentum. By 5 p.m. Monday—on the eve of the Reserve Bank’s board meeting—the futures market had already priced in a 0.25% rate cut by November. It also projected two additional cuts, one by February and another by April, totaling three cuts ahead of the federal election in May.
A 0.25% cut would save a borrower with a $600,000 variable-rate mortgage around $90 per month. If all three cuts materialize, the total savings would amount to $275 per month.
Impact of a US Recession on Australia
Australia’s Reserve Bank has explored how a U.S. recession could impact the local economy.
According to studies released under freedom of information laws, the direct effects would be limited, as much of Australia’s income is driven by trade with China. However, the indirect effects could be more significant, with declining consumer confidence and increased financial market uncertainty making it harder for businesses to secure loans.
The analysis suggests that within a year, Australia’s GDP could be 0.5% lower than it would have been without a U.S. downturn. Given the economy’s sluggish growth in the first quarter of this year, such a decline could be enough to tip Australia into a recession of its own.
Australia is Already Facing a Personal Recession
The Reserve Bank’s report, released on Tuesday, highlights that many Australians are already experiencing a personal recession.
It notes that GDP per capita—income per person—has fallen by 1.6% since mid-2022.
The report also points out that several central banks, including the European Central Bank, Bank of Canada, Bank of England, and Sweden’s Riksbank, have responded to easing inflation by cutting interest rates. Additionally, New Zealand’s Reserve Bank and the U.S. Federal Reserve are preparing to do the same.
Despite this global trend, the RBA governor maintains that Australia won’t follow suit anytime soon. However, financial markets are betting that rate cuts are on the horizon.