Australian inflation eases, but RBA tightening looms

Australian inflation came in slightly softer than expected, but the figures still point to further monetary policy tightening, according to CreditorWatch Chief Economist Ivan Colhoun.

Both the monthly and quarterly trimmed-mean measures rose by less than forecast, suggesting that underlying inflation had been running at about 3.25% before the Iran conflict. That is below the 3.5% annual pace recently cited by the Reserve Bank of Australia's deputy governor, but it remains above the central bank's 2.5% target.

His assessment adds to the debate over the Reserve Bank's next move, with markets still expecting another interest rate increase. While tighter policy is still needed, he argued that the timing is less certain because higher fuel costs and geopolitical risks have added pressure on households, companies, and confidence.

Fuel prices were the main driver of the latest headline inflation result. Petrol prices rose 33%, and retail diesel prices increased 41%, with diesel accounting for about 10% of the fuel basket.

According to Colhoun's analysis, those increases added 1.1 percentage points to headline inflation. As a result, the annual inflation rate for the monthly series accelerated from 3.7% to 4.6%, while the quarterly annual rate edged up from 3.4% to 3.5% as fuel prices rose by about 5.5% over the quarter.

The breakdown across inflation categories shows how broad price pressures remain. Only communications and furniture, household equipment and services are running below the 2.5% target, and together they account for about one-tenth of the consumer price index.

Recreation and culture, along with insurance and financial services, are close to the target and make up 18% of the index. The remaining 72% of the basket is recording inflation of 3% or more, while 55% is above 4%.

That breadth matters for the Reserve Bank because it suggests inflation is not confined to a narrow set of volatile items. Housing-related components remain a major source of pressure, although rents rose only 0.2% month on month.

Electricity prices continue to reflect the earlier end of subsidies annually. Colhoun also noted that earlier rises in gold and silver prices had translated into sharp increases in jewellery prices.

Rate decision

The central question is whether the Reserve Bank moves immediately or waits for more clarity on energy markets and the wider economic outlook. Markets are strongly positioned for a tightening move at the next board meeting, partly because recent Reserve Bank communication has been interpreted as hawkish.

He argued, however, that caution has become more warranted because energy costs are now affecting both demand and prices. Weaker consumer and business confidence, together with softer auction clearance rates, point to the risk that higher borrowing costs could compound the damage from elevated fuel bills.

Business liaison data gathered by the central bank may therefore become more important in the policy decision than public market pricing suggests. Uncertainty over the Strait of Hormuz also complicates the outlook, as any prolonged disruption would raise the risk of much higher oil prices, fuel rationing, and recession in Australia and abroad.

"Today's inflation data was a little better than expected, but also confirmed that even before the Iran conflict, Australian inflation continued to run materially above the RBA's target. That suggests further monetary policy tightening will be delivered, with the only question being the timing," said Ivan Colhoun, Chief Economist, CreditorWatch.

In his view, an immediate rate rise would not by itself tip the economy into recession. But the combination of tighter policy and current fuel costs would add significant pressure to businesses already dealing with weaker confidence and softer conditions.

Economic risk

A wait-and-see approach could be justified if policymakers want more evidence on whether disruption to global energy routes will persist. Colhoun noted that four of the nine members of the Monetary Policy Board had already taken that position in March.

"The market remains substantially priced for a move next week, though I assess there to be a lesser risk than priced given the substantial impacts on confidence and auction clearance rates and the unknown duration of the Strait of Hormuz closure. That suggests a prudent course of action could be to await further clarification of the Strait of Hormuz closure, before tightening further, as an extended closure carries a significant risk of recession," said Colhoun.

Even so, he maintained that the broader inflation picture still supports tighter policy once conditions stabilise.

"Importantly, this does not mean that further monetary policy tightening is not required. My base case is that the Strait of Hormuz situation will be resolved relatively soon, allowing the pre-Iran improving US and Australian economy scenarios to re-establish and the RBA to continue to enact tighter policy," said Colhoun.