The Reserve Bank of Australia raised its benchmark interest rate by 25 basis points to 4.35%, arguing that inflation is likely to remain above target for some time and that the balance of risks is still tilted towards stronger price pressure. The main new shock to the economy is the conflict in the Middle East, which has led to a sharp rise in prices of oil, LNG and other commodities important for agriculture and industry.
In March, CPI inflation rose to 4.6%, with higher fuel prices adding around 0.8 percentage points. Core inflation, measured by the trimmed mean, reached 3.5% year on year, confirming that price pressure is not limited to energy alone.
The RBA assumes that, under its baseline scenario, the cash rate will rise in line with market pricing to around 4.7% by the end of 2026. Higher fuel prices are expected to reduce real household incomes, while tighter financial conditions are likely to weigh on consumption and investment.
As a result, the GDP growth forecast has been lowered. The Australian economy is expected to grow by around 1.3% year on year by the end of 2026 and by around 1.4% in 2027–2028. The labour market remains relatively tight, but the RBA expects it to weaken gradually. The unemployment rate, which stood at 4.3% in March, is projected to rise to around 4.7% by mid-2028.
Inflation is expected to decline only slowly. The RBA forecasts that CPI will peak at around 4.8% in mid-2026, fall to 4.0% by the end of the year and move closer to 2.5% by mid-2028. The central bank is particularly concerned about second-round effects, meaning a situation in which higher fuel prices feed through into the prices of other goods and services, and then into inflation expectations and wages.
Short-term inflation expectations have already increased, although long-term expectations remain anchored close to the midpoint of the inflation target. However, if expectations of higher inflation become entrenched, the central bank could be forced to maintain a more restrictive monetary policy stance.
The RBA’s report also indicates that household consumption was weaker than expected even before the conflict began. After its escalation, consumer and business sentiment deteriorated further. However, the central bank notes that there is so far no evidence of a sharp decline in actual spending.
Financial conditions in Australia have tightened, as banks pass through earlier and current rate hikes to mortgage and business lending rates, while bond yields have also risen. At the same time, credit continues to grow quickly, especially housing and business lending. This makes it more difficult to assess how restrictive current monetary policy really is.
The Australian dollar strengthened in trade-weighted terms, partly due to the rise in Australian yields relative to other developed economies.
The main risks for Australia remain linked to a prolonged conflict, persistently high energy prices, rising inflation expectations, weaker consumption, reduced business investment, deteriorating conditions among trading partners and possible tensions in financial markets. The RBA also points to risks from China, where weakness in the property market and household credit demand remains visible despite support from public financing.
Asian economies are particularly exposed to a prolonged rise in energy prices because many of them are energy importers and have a large share of energy-intensive industry.
The RBA’s overall conclusion is that Australia is not in a recessionary scenario, but it is entering a difficult period of elevated inflation, slower economic growth and a gradual rise in unemployment. The current interest rate differential between Australia and the United States stands at 35 basis points in favour of the Australian dollar, while AUD/USD is trading at 0.72017.
