Inflation vs growth: RBA is choosing to slow the economy as it tackles inflation

Downside risks to economic growth and further increases in inflation – that is the combination of news unfolding in the Australian economy as the Middle East war underpins high oil prices and fuels inflation.

This sentiment and erratic market conditions is making it difficult for policy makers, business, governments and householders to plan ahead with any degree of confidence.

The RBA has reacted to the inflation outcomes and risks for persistently high inflation with another interest rate increase in May, a move which took official interest rates to an equal 14 year high of 4.35 per cent. RBA Governor Michele Bullock confirmed the general view that monetary policy settings are ‘restrictive’. There have been 75 basis points of interest rates hikes between February and May 2026.

The revised economic forecasts from the RBA that were released with the interest rate decision made for bleak reading.

The RBA is forecasting annual GDP growth to fall below 1.5 per cent for more than a year, for the unemployment rate to rise to 4.7 per cent and for underlying inflation remaining above the mid-point of the target band until 2028. If this scenario holds, businesses should prepare for an extended period of economic funk, and be alert to downside risks if global economic trends deteriorate to any significant extent.

There has been only limited hard economic data in Australia that captures the impact of the oil and interest rate double-whammy. Indicators that have been released include for consumer confidence and business conditions, both of which have weakened markedly. The household spending data were superficially strong, rising 1.6 per cent in March, but this was boosted by the panic buying of petrol as the oil shock began and intensified.

Other key data point to moderate growth prior to the impact of the oil shock. The unemployment rate was steady at 4.3 per cent, the trend in employment growth was moderate while dwelling construction is a bright spot and is moving higher.

House prices are weakening. Prices in Sydney and Melbourne are now falling, while price increases in the other capital cities are slowing. The balance between dwelling supply and demand is steadily correcting, particularly with a moderation in population growth.

After the 5 May interest rate rise from the RBA, money markets were pricing in just one more 25 basis point hike, which would see the peak interest rate in this cycle settle at around 4.60 per cent.

New Zealand

The global oil shock is posing a threat to what was an encouraging economic recovery from the 2025 recession. The ANZ survey of business confidence which had risen strongly since the middle of 2025 and has a solid correlation with economic growth, fell sharply in April. In what is a concern for the inflation outlook, firms are showing significant upside cost pressures, which is a common story globally.

In data prior to the oil shock, consumer spending had been recovering, a trend that was being reflected in the early stages of a pick up in job vacancies and a trough for wages growth.

The RBNZ has reaction with caution to the oil shock and in recent commentary has signalled the need for caution form what may still be a ‘temporary spike’ in inflation. It has also been emphasising the need to balance the need for lower inflation whilst still supporting the economic recovery by not lifting rates too soon.

Markets continue to price in a relatively moderate interest rate hiking cycle with the first rate rises generally expected during the second half of 2026. There has been relatively little change in medium term expectations, with approximately 100 basis points of rate hikes priced in by late 2027.

Currencies

The AUD remains strong with the commodity price surge a major support. It has been in a broad 0.70 – 0.72 US cents range in the past month and remains strong on most cross rates. The NZD has been more subdued around US 59 cents. The AUD/NZD cross continues to rise, and is around a fresh 13 year high of 1.22.