RBA Holds, Warns of Rate Hike if Inflation Risks Materialise

The Reserve Bank of Australia left the cash rate unchanged at its August meeting, a decision markets had fully priced in. What caught attention was the narrower warning in the accompanying statement. The board is prepared to raise rates if upside risks to inflation materialise, Chief Economist Luci Ellis said. That is more specific language than May's "if needed" formulation.

Headline and trimmed mean inflation have both come in lower than the RBA expected in May. The labour market and housing market are both weaker than the central bank projected. Those outcomes, the board said, strengthened its assessment that monetary policy is "somewhat restrictive" – likely enough to bring inflation below the midpoint of the target range by 2028.

Inflation risks are still skewed to the upside, the RBA said, and the labour market remains tight. Westpac economists said they expect the central bank to maintain a hawkish tone while holding steady through late 2026 and early 2027. By August 2027, they forecast a period of below-trend growth, an unemployment rate above full employment, and a trend deceleration in annual inflation will warrant the first of three 25-basis-point cuts. The next two would follow in November 2027 and February 2028. Until that relief arrives, the consumer is likely to remain cautious on spending and housing, topics the bank's latest Red Book examines in depth.

The July NAB business survey captured the business reaction to the breakdown of the US/Iran Memorandum of Understanding and the brief spike in Brent crude above $100 a barrel. Business conditions edged up one point to 4, still showing resilience. Confidence registered a second consecutive reading of minus 6 – 11 points below its long-run average and within the bottom 10% of outcomes recorded since 1997.

Input cost increases are materially affecting business profitability, particularly in sectors where weak demand limits the ability to pass costs on. The survey's profitability gauge remained only modestly below its long-run average, and the employment index held in line. Forward orders fell three points in July to minus 3, a signal NAB said warrants close monitoring.

Offshore, the focus was on benign US inflation data. Headline prices rose 0.1% in July, and 0.2% excluding food and energy. Annual headline inflation at 3.4% is still a multiple of the Federal Reserve's 2% target. Core inflation has moderated to 2.5%, and recent monthly outcomes suggest further progress is underway, economists said.

Since December 2025, core goods prices have been essentially flat. Core services inflation has averaged 0.3% per month over the period, with an outsized contribution from shelter. The six-month annualised measure excluding food, energy and shelter was just 1.6% in July, compared with 2.4% for the traditional ex-food-and-energy gauge. There is little the Fed can do about shelter inflation in the short to medium term. Inflation across the rest of the basket does not suggest a rate hike is necessary now or in coming months, economists said.

July's nonfarm payrolls report also argued for restraint. The employment gauge surprised to the downside at minus 23,000, following a 103,000 downward revision to the prior two months. The household survey was weaker still, with 87,000 fewer people reporting they were employed in the month, continuing a six-month trend averaging a monthly decline of 153,000.

Declining participation continues to mask the deterioration in household employment, economists said. Had participation not fallen 1.2 percentage points since January 2025, the unemployment rate would be through 5.0%. Average hourly earnings are increasingly reflecting labour market slack, rising just 0.1% in the month and slowing the annual pace to 3.2%.

Westpac economists said they expect the US economy to continue showing resilience, growing around trend through 2026 to 2028. The household sector is set to remain under considerable pressure, with excess capacity likely building in the labour market and the ability to unlock housing wealth constrained by borrowing costs and uncertainty. A full update of the bank's global analysis and forecasts will be published in its August Market Outlook on Westpac IQ.