RBA cuts cash rate 0.25ppts to 3.6%, with more cuts assumed to be needed to keep inflation at target. Worst-case outcomes on global trade have been avoided, but RBA is now more pessimistic about near-term growth in output and productivity.
- The RBA Monetary Policy Board (MPB) cut the cash rate by 0.25ppts to 3.6% following its August meeting as widely expected. With underlying inflation clearly inside the 2–3% target range and heading towards its 2½% midpoint, the need for restrictive monetary policy is dissipating. The updated inflation forecasts are largely unchanged but show a 2.5% at the end of the (extended) forecast horizon to December 2027.
- The RBA’s forecasts are predicated on further cuts to the cash rate as expressed by market pricing last week. The trough rate implied by this assumption is now sub-3%, consistent with our own view. In the press conference, the Governor did not rule out back-to-back cuts and emphasised that the MPB would take things meeting by meeting. The every-other-meeting pace implied by our own recent forecasts still seems a reasonable base case, though.
- The RBA has downgraded its near-term view of trend productivity growth, and hence GDP growth. Importantly, this does not imply a downgrade to the long-run trend. In addition, the RBA has moved away from its view of a year ago that slow productivity growth presented an upside risk to inflation.
Today’s decision by the MPB to cut the cash rate was widely anticipated. Inflation is at target and likely to stay there. The labour market has eased further, though the statement still characterises it as ‘a little tight’. It was hard to construct a scenario where the information flow between the July and August meetings would have made the MPB want to keep rates on hold in August. Nonetheless, the benign print for Q2 underlying inflation and slight pick-up in unemployment were as expected. This helped ‘seal the deal’ and gave the six MPB members who had previously wanted to wait the evidence they needed to be comfortable cutting the cash rate in August. They joined the three who had voted for a cut in July for a unanimous vote this time, as we expected.
The evolution in the RBA’s views since May, as expressed in its forecasts, has been fairly minor. The unemployment forecast is unchanged, implying no further increases in the unemployment rate from here. At these levels, the RBA assesses that ‘some tightness remains’ in the labour market. This benign outcome is vulnerable to labour supply rising faster than working-age population growth, given the multi-decade trend increase in female participation.
The forecasts for trimmed mean inflation now show a 2.5% for end-2027, the additional period as the forecast horizon rolls forward with time. But the flat-as-a-pancake 2.6% rate remains the forecast for the whole period covered by the May forecasts. Within the total, housing-related inflation is expected to be a little higher than previously forecast, while traded goods inflation could be a little lower, given slower global growth amid trade disputation.
The SMP highlights that trade patterns have adapted to US tariffs relatively smoothly, even though tariff rates have landed somewhat higher than assumed a few months ago. In particular, the Chinese economy has remained resilient; a key judgement in the forecasts – which we share – is that the Chinese authorities will continue to use policy stimulus to ameliorate the impact from trade restrictions and ongoing US policy uncertainty.
The forecasts for public demand and consumption have been lowered relative to the May forecasts. However, both are still expected to pick up over the next couple of years. The SMP points to government budgets in support of a view that the weakness in public demand will be temporary. Lower interest rates and some positive real income growth will both support consumption growth, as also implied by our own forecasts.
The revised RBA forecasts are predicated on the cash rate declining further from here, with the implied trough at 2.9% in 2026, similar to our own expectations. In the media conference, the Governor highlighted that a couple more rate cuts were necessary to achieve the current forecasts and keep inflation at target. She also noted that holding rates constant from here would result in inflation falling below the target midpoint. The Governor did not rule out back-to-back cuts and emphasised that the MPB would take things meeting by meeting. The every-other-meeting pace implied by our own recent forecasts still seems a reasonable base case, though.
RBA productivity view finally catches up to Bank of Canada
The main change in the RBA’s views relates to GDP growth and productivity. Specifically, the RBA has revised down its assumption on trend productivity growth from around 1%yr to 0.7%yr, citing consistently lower outcomes than expected recently. The forecast for GDP has been revised down proportionally, though a pick-up in growth is still expected over the next couple of years.
The SMP devoted an entire chapter to explaining the change. Some of the recent weakness in productivity was acknowledged as being due to industry-specific factors that will unwind. These are the increased share of the non-market sector and the decline in mining productivity that Westpac Economics has been flagging for some time; the RBA’s quantitative estimates of the drag align with our own previously published estimates. However, the trend growth rate that the RBA expects productivity to converge to as these factors unwind is now this lower 0.7%yr rate. In the media conference, the Governor characterised the change as being a fix to a ‘puzzle’, whereby their inflation and unemployment forecasts turns out to be roughly correct, but GDP and wages growth both turned out to be weaker than forecast.
One consequence of the revised view of trend productivity growth is that the RBA’s view of potential or trend output growth over the next couple of years is also lower now. To put this in perspective, the downgrade to trend GDP is similar to the one implied by population growth being lower (1.2%–1.3%) in the forecast period than the 1.5%–1.6% range seen in the years leading up to the pandemic. The differences relate to the implications for (per person) living standards.
The recognition that productivity growth has been slower in recent decades than it was in the IT-boom of the late 1990s is not new (see this 2021 speech and this 2023 Bulletin article). It is also not Australia-specific but relates to a range of global factors, including the level of business dynamism, competition and adoption of technology. The downgraded RBA forecasts for business investment – and thus growth in the capital stock – have particular salience for this issue. These were reduced by more than GDP growth was, in recognition that slower demand growth lowers the return to future investment. This points to a disturbing path-dependence of lower growth begetting even less future supply capacity. If true, it would make a policy mistakes of keeping policy too tight even more problematic.
Importantly, the RBA does not assume that the weaker trend for the next couple of years necessarily implies that the long-term trend growth in productivity (and hence potential output growth) will be low. This would have been a big call given the current optimism around AI and other technologies and their implications for productivity growth.
What is new is that the RBA explicitly states that this reassessment has no implications for inflation. All the hand-wringing a year ago about wages growth being too fast given trend productivity growth turned out to be misplaced. The explicit assumption now is that households and businesses have (likely subconsciously) adapted to slower productivity growth, which is why wages growth is slower. This is exactly how the Bank of Canada framed the issue more than a year ago. Accordingly, this change in view has not boosted the inflation forecasts, but if anything has reduced the RBA’s views of upside risks to inflation from this source and made it less nervous about further rate cuts.