RBA Delivers: Cheaper Rates, Cautious Optimism

The Reserve Bank of Australia (RBA) has lowered the cash rate by 25 basis points to 3.60 percent, its third rate cut this year, in response to a sustained slowdown in inflation and signs of easing labour market conditions. This decision is intended to provide additional support to household spending and business investment at a time when global uncertainty remains elevated and domestic momentum is improving but uneven.

Inflation in Australia has moderated significantly since its 2022 peak. The latest data show underlying (trimmed mean) inflation at 2.7 percent and headline inflation at 2.1 percent, both inside the RBA’s 2–3 percent target range. The disinflation has been broad-based, aided by earlier interest rate increases and temporary cost-of-living support measures.

The domestic economy is showing early signs of improvement. Private demand has been recovering gradually, supported by rising real household incomes and modestly easier financial conditions. Labour market indicators have softened, with unemployment rising to 4.2 percent in the June quarter, but participation remains high and labour underutilisation low by historical standards. Wages growth has eased from its peak, but weak productivity continues to push unit labour costs higher.

Overall, we think confidence is growing but softer conditions suggest the economy is at a turning point. Rate cuts are lifting sentiment, but the hard data are yet to catch up. The coming months will be critical in determining whether optimism translates into tangible economic gains. We expect the RBA to deliver just one more cut in November to end the year with policy rates at 3.35%. The risks to this call are skewed to the downside, with an additional 25 bps cut possible taking the policy rate to 3.10% by December 2025.

Relief for Households and Businesses

The cut to 3.60 percent will provide immediate relief to households with variable-rate mortgages and other floating-rate debt. However, the RBA will be watching closely to see if this additional spending power translates into higher consumption or higher savings. If households remain cautious, as they have so far, the stimulatory effect could be weaker than intended. On the other hand, a faster-than-expected pick-up in spending could help lift growth but risks putting upward pressure on prices.

For businesses, the latest rate cut reduces borrowing costs, potentially encouraging investment. The NAB business survey, also released today, indicated that confidence is rising, up to +7 in July from +5 in June, suggesting many firms see improved prospects ahead. This is likely underpinned by the RBA’s shift towards a gradual easing path and a perception that cost-of-capital pressures will continue to fall.

Yet, conditions weakened slightly to +5, with trading and profitability measures easing. This highlights that while the outlook is improving, day-to-day business performance remains under strain from elevated input costs, wage pressures, and uneven demand. Retail price growth of 1.1 percent and producer prices up 0.9 percent indicate that cost pass-through remains a challenge in competitive sectors. For smaller businesses in particular, margin pressures may persist even as financing becomes cheaper.

Global Considerations

Internationally, trade tensions remain a key risk despite some de-escalation. Higher US tariffs and policy uncertainty are expected to weigh on global growth into 2026, though the risk of a severe global trade war has eased. For Australia, the direct effect is limited as resource exports dominate and remain in demand. However, shifts in global supply chains could alter import prices and competitive dynamics. Cheaper imported goods, particularly from China, may benefit retailers but put pressure on domestic manufacturers.

Risks and Outlook

The RBA has trimmed back its GDP forecasts across the board. The projection for June 2025 has dropped to 1.6% from 1.8%, and growth through 2026 is now expected to be more gradual than earlier anticipated.

Headline inflation is expected to peak briefly at 3.1% by December 2025 before easing toward the 2.5% mark by mid-2027. Underlying inflation (trimmed mean) remains firmly anchored in the 2–3% target range. Meanwhile, the unemployment rate is projected to stay around 4.3%, signalling a stable, near-full-employment labour market.

A key change lies in the assumed path for the cash rate: it's expected to fall more than previously forecast reaching just around 2.9–3.1% over the next two years. This signals a more accommodative stance relative to the May outlook when the path was higher and more conservative. Its important to note that policy path assumptions are based off market participants’ predictions.