Charlie Jamieson, Chief Investment Officer

The Reserve Bank of Australia’s (RBA) surprise decision to leave interest rates unchanged last week is a return to confusion and uncertainty which plagued the leadership of the previous RBA Governor Phillip Lowe. This added uncertainty introduced by the Bank’s approach stifles growth and business investment, effectively imposing a new ‘uncertainty premium’ to be added to business planning and investment around the country. Ironically, this may act as a handbrake on the very growth and animal spirits the RBA wishes to unlock.

The RBA’s decision to hold the cash rate steady at 3.85% stringently defied market expectations, which had all but fully priced the meeting as a lock, with a 94% probability of a rate cut. Such a significant disconnect is rare – this is only the fourth time in recent history the RBA has acted against market pricing when expectations for a cut exceeded 75%. This level of disconnect is virtually unprecedented when compared with the US Federal Reserve, where market pricing and policy decisions tend to be far more aligned. Of course, the RBA is free to disagree with market pricing, however, allowing such pricing to coagulate to such certain levels is a vast failure of the RBA’s previous communications with the market, something Governor Bullock has made central to her tenure. Her focus on rebuilding transparency and credibility follows earlier missteps, including Yield Curve Control removal (without a formal board meeting – an enormous process failure), and broken promises around the movement of interest rates post-COVID, which crushed new homeowners and mortgagees.

This comes after another surprise at the RBA’s May meeting, where the bank rapidly moved towards a dovish tone – revealing that the Board had even discussed a 50-basis point rate cut. Governor Bullock’s comments at the time suggested a sharp pivot towards easing. More importantly, it signals a central bank which is totally reactionary, responding only after economic data confirms what is widely expected, and willing to forego the time delays associated with such reactionary policy which undermines the Bank’s ability to act pre-emptively.

The current meeting decision likely reflects a nuanced debate on the timing rather than the direction of future rate cuts amid economic uncertainties.

We did, however, gain some insight into the RBA’s internal thinking. For the first time, the RBA disclosed the voting split – six board members voted to keep rates unchanged, while three supported an immediate cut, indicating a close division on timing issues. The Board also emphasised its preference for quarterly inflation data over volatile monthly figures and noted caution given that underlying inflation has only recently entered the target range. There are also concerns that temporary government subsidies may be lowering headline inflation artificially, masking the true trajectory of price pressure.

This should see economic forecasters adjust the timing of their rate cuts to the meeting dates after the quarterly CPI updates, being February, May, August and November as most likely meetings dates for future policy action.  Seemingly, the Board considers that economic uncertainties have improved, noting that the worst-case US-China trade war scenario has lessened since May, reducing immediate pressure to cut rates aggressively. However, weak labour productivity is raising business costs, squeezing profit margins, and could lead to renewed inflation pressures if businesses pass these costs on to consumers, further complicating the inflation outlook.

Despite the RBA’s chopping and changing, investors should feel comfortable that the destination for lower interest rates is still firmly the central scenario – this little episode merely elongates the journey but does little to change the end result. If anything, it may lower the terminal rate by delaying needed stimulus to the private sector, as the RBA appears willing to drip feed in policy stimulus, and only after quarterly inflation figures confirms the case for action.

With the May total CPI indicator printing at 2.1% year-on-year, 2.4% year-on-year on the trimmed mean measure, the first-time core inflation has been below the 2.5% target band midpoint since 2021, inflation seems to be yesterday’s monster. Further rate cuts will very likely be delivered in August. First quarter GDP in Australia rose just an anaemic 0.2% quarter-on-quarter, 1.3% year-on-year. Although the labour market remains resilient, with the unemployment rate flatlining at 4.1%, a large part of the employment market continues to be driven by public sector spending.

As for the global outlook, the RBA remains concerned that the average US tariff rate could be far higher than previously expected in early 2025. As US tariff policy remains prone to changes that could depress and disrupt global trade, lowering Australia’s growth prospects into 2026.

In such an environment, high quality fixed income will continue to provide a solid anchor for portfolios, against the only certainty being vast uncertainty in today’s “Trumpian” world. In this context, a defensive positioning remains prudent.