In brief
- The Reserve Bank of Australia (RBA) lowered the Overnight Cash Rate by 25bps to 3.85%, citing moderating inflation as the reason for easing monetary policy.
- Although domestic economic growth is robust, the RBA remains cautious due to global economic uncertainty and volatile markets impacting Australia's economic outlook.
- While AUD deposit rates are declining and the yield curve has flattened, interest rates remain elevated compared to historic standards.
A confident cut
At its latest monetary policy meeting, the RBA decided to lower the cash rate target by 25bps to 3.85%. The RBA justified the decision by highlighting that “inflation continues to moderate” with trimmed mean inflation below 3% for the first time since 2021. Headline inflation remains within the target band of 2–3%. While economic data remained robust, the board noted that the growth outlook had deteriorated due to heightened economic and political volatility. Its forecasts are “subject to considerable uncertainty” given the unpredictable geopolitical backdrop.
During the subsequent press conference, Governor Bullock characterized the rate cut as a "confident decision." She expressed satisfaction with the progress made towards the bank's commitment to achieving price stability while maintaining full employment amidst heightened global uncertainty. Governor Bullock acknowledged that the board had deliberated on the possibility of keeping rates unchanged or implementing a larger cut. Ultimately, they reached a consensus on the current decision. She refrained from committing to further rate cuts yet emphasized that the RBA possesses the capacity to act swiftly should future circumstances necessitate such measures.
Fig 1: The RBA cut rates for the second time in the current cycle, BBSW has declined in anticipation of rate cut.
Source: RBA, Bloomberg and J.P. Morgan Asset Management; data as of 20th May 2025
Robust data, cautious outlook
The RBA's decision to cut rates was underpinned by the continued moderation in inflation. The March quarter data showed annual trimmed mean inflation at 2.9%, and headline inflation at 2.4%, both comfortably within the target range. The RBA noted that "inflation has fallen substantially since the peak in 2022," attributing this to higher interest rates that have helped bring aggregate demand and supply closer to balance.
First quarter economic growth was better than expected, meanwhile, recent economic data has remained strong, bolstered by solid performance in the housing and export sectors and a robust labour market. However, wages growth has softened over the past year, and productivity growth has not picked up, leading to high growth in unit labor costs.
Despite the positive data, the RBA remains cautious about the outlook. The statement acknowledged that "uncertainty in the world economy has increased over the past three months," with geopolitical uncertainties and volatile financial markets posing risks to global economic activity. These developments contributed to a slight downward revision to RBA’s growth, employment and inflation forecasts.
Fig 2: Inflation has declined to within the RBA’s target range. Unemployment remains close to record lows.
Source: Bloomberg and J.P. Morgan Asset Management; data as of 20th May 2025.
Conclusion
The RBA's decision to cut interest rates reflects a growing confidence that inflation risks “have become more balanced”, allowing a “somewhat less restrictive” monetary policy. Governor Bullock indicated that if inflation continues to decline, the bank has capacity to further reduce interest rates. However, amid volatile domestic and international markets, the RBA's economic outlook remains uncertain. Therefore, despite a dovish stance, the bank avoided committing to future rate cuts, stressing its reliance on data-driven decisions.
Concerns over U.S. tariffs had led investors to anticipate multiple RBA rate cuts. With trade tensions easing and tariff introductions postponed, the number of expected rate cuts has decreased. Despite this, investors fully anticipated the May cut and now project three more cuts in 2025, moving base rates towards neutral.
Upside inflation risks have diminished, while downside growth risks have increased. Yet heightened uncertainty and solid economic data suggest the RBA will likely proceed cautiously with any additional rate cuts. For AU$ cash investors, deposit rates will decline immediately while the yield curve has flattened in anticipation of further rate cuts. Despite this, interest rates remain elevated compared to historic standards and diversifying across tenors and strategies could present attractive return opportunities.