Australia’s annual headline inflation rate slowed more than expected in May, but a hotter underlying inflation reading is likely to keep the Reserve Bank of Australia (RBA) cautious on interest rates.
The consumer price index eased to 4% year-on-year in May from 4.2% in April, according to the Australian Bureau of Statistics (ABS).
On a monthly basis, headline CPI fell by 0.7%, reversing a 0.4% gain in April. Economists had expected annual inflation to ease to 4.3% and monthly inflation to fall by 0.4%.
The softer headline result was helped by easing energy and transport costs after oil prices retreated from above US$100 a barrel amid talk of a peace deal in the Middle East.
However, the trimmed mean measure, which strips out volatile items and is closely watched by the RBA, rose to 0.4% in May from 0.3% in April. On an annual basis, trimmed mean inflation lifted to 3.6% from 3.4%, above expectations of 3.5%.
Core inflation complicates RBA outlook
The mixed CPI report leaves the RBA facing a difficult policy trade-off after raising rates three times this year to bring inflation closer to its 2.5% target.
The central bank left the cash rate unchanged at 4.35% last week, but markets are still pricing in a roughly 60% chance of one more increase before the end of the year.
Deloitte Access Economics partner Stephen Smith said the RBA would be cautious about over-interpreting a single monthly CPI print, particularly against an uncertain global backdrop.
“The government’s temporary fuel excise cut has masked the extent to which inflation pressures remain a problem for the Australian economy and is delaying some of the price growth pass-through to other sectors. These pressures will become more visible as the policy is unwound through July,” he said.
“The Reserve Bank is already dealing with a difficult mix of softening growth and elevated inflation. The economy slowed sharply in the March quarter, households are cautious, and the labour market is cooling.”
Smith said that may normally suggest the central bank needs to be patient. But with underlying inflation now above the 2.5% target for almost 5 years, May’s result means the Reserve Bank must remain vigilant.
“For households, the message is familiar but uncomfortable. Inflation is no longer surging, but it is still eroding purchasing power. Until price growth slows more convincingly, cost-of-living pressure will remain real, and the risk of another rate hike will remain firmly on the table,” he said.
Deloitte still expects 1 further rate rise.
Wage and housing pressures remain key risks
VanEck Head of Investments & Capital Markets Russel Chesler said the fall in headline inflation was encouraging, but the lift in trimmed mean inflation was a warning sign.
“Inflation is no longer just sticky, it is starting to look stubborn. While today’s fall in headline inflation to 4.0% is encouraging, what is worrying and presents a real warning sign, is the trimmed mean inflation lifting from 3.4% to 3.6%. That is moving in the wrong direction and further away from the RBA’s 2% to 3% target band,” said Chesler.
“With fuel prices having fallen recently, and the fuel excise cut still in place, albeit at a reduced level, most of the first-round effects of the oil crisis should now have fed through. The biggest movers in May were Housing up 6.5%, followed by a 3.3% rise in Food and 3.3% in Transport. The largest driver of hosing inflation was Electricity up 21.1% with the removal of the electricity rebates. The concern now is not just what is pushing prices up today, but whether those pressures are becoming embedded across the economy.
“Wages are the next flashpoint. The 6% lift in the lowest minimum wage rates and 4.75% rise in award wages could keep services inflation higher for longer, particularly if private sector employers are forced to follow. That is where inflation becomes harder to dislodge, because wage-driven price pressure tends to be more persistent than fuel or goods shocks.
“The RBA now faces an increasingly uncomfortable trade-off. We do not expect today’s rise in trimmed mean inflation to be enough to force another hike in August 2026, but the case for easing has become harder to make. GDP growth is weakening, unemployment has risen to 4.5%, households are running down savings buffers, and spending is already outpacing disposable income.
“The warning lights are flashing across the consumer economy. Last week’s national auction clearance rate dropped to 47.4%, the lowest level since the onset of the COVID-19 pandemic in 2020. Consumer sentiment is also deeply pessimistic, with the Westpac-Melbourne Institute Consumer Sentiment Index at 80.6, among the weakest levels recorded in the survey’s fifty-year history.
“This is the stagflation risk. Inflation is proving difficult to bring down at the same time the economy is losing momentum. That may not mean recession, but it does mean investors should be careful about assuming the next phase will be easy. We think the terminal rate for this cycle is either the current 4.35%, or 4.6% if the RBA is forced to move once more later this year,” said Chesler.
Markets look to labour data
BNY APAC Macro Strategist Wee Khoon Chong said the May CPI report delivered a mixed signal.
“Australia’s May CPI report delivered a mixed signal. Headline inflation eased to 4.0% y/y from 4.2%, but trimmed mean inflation, the RBA’s preferred core measure, accelerated more than expected to 3.6% y/y from 3.4%.
“The data is unlikely to shift the RBA from its current wait-and-see stance in the near term. However, the firmer core inflation reading reinforces our view that further policy tightening remains possible before year-end. Markets appear too complacent in assuming the current tightening cycle has peaked.
“Market reaction was limited, with AUD and front-end Australian rates little changed, as investors look ahead to tomorrow’s employment report for a clearer signal on the labour market and policy outlook.”
RBA deputy governor Andrew Hauser is due to speak in Adelaide this afternoon, while ABS Labour Force data is scheduled for release on Thursday.
Sharemarket reaction may be premature
Pitcher Partners CIO Cameron Curko said the initial sharemarket response was positive, with the ASX 200 rising after the release, led by rate-sensitive sectors including information technology, utilities and real estate.
“Headline inflation rose 4% for the year to May, shy of expectations for 4.2% growth. The initial sharemarket reaction has been positive with the ASX 200 rising post-release, led by rate-sensitive sectors such as information technology, utilities and real estate. The headline deceleration appears promising but nuance is required. A major contributor was a 3.9% decline in transport costs thanks to declining oil prices as well as the halving of the fuel excise. The latter looks set to unwind in July unless extended by the Prime Minister. In addition, structural drivers of inflation remain intact with housing costs climbing thanks to the feed through of higher labour and raw materials into new housing pricing as well as a tight rental market. Healthcare and education also continue to rise materially above the 2-3% target range.
“The market reaction assumes the RBA will shift to a more supportive policy stance. Barring a material worsening of the labour market however we think this reaction is likely to be premature. Core inflation actually accelerated to 3.6% and needs relief to come in some of these structural categories before the RBA can gain confidence in a 'mission accomplished'."