Australian central bank cuts rate to two-year low amid global headwinds

Australia’s central bank, the Reserve Bank of Australia (RBA), on May 20 lowered its main cash rate by 25 basis points to a two-year low of 3.85 per cent.

The decision, which marks the second rate cut this year, was driven by the uncertainty in the global economic outlook and cooling inflation, though the RBA maintained a cautious stance on the need for further easing.

The move was widely anticipated by markets, given a slowdown in domestic inflation and heightened global uncertainty following recent US tariff announcements. Headline consumer price inflation held at 2.4 per cent in the first quarter of 2025, and a key trimmed mean measure of core inflation slowed to 2.9 per cent, bringing it back into the RBA’s 2 per cent to 3 per cent target band for the first time since late 2021.

“Inflation is in the target band, and upside risks appear to have diminished as international developments are expected to weigh on the economy,” the RBA board stated.

They assessed that this rate cut would make monetary policy “somewhat less restrictive”, but emphasised continued caution about the outlook, especially given the elevated uncertainty surrounding both aggregate demand and supply.

Trade tensions cast a shadow

A significant factor influencing the RBA’s decision is the rapidly evolving global trade landscape. Since the RBA’s last meeting in April, US President Donald Trump’s tariffs have continued to roil financial markets and disrupt business plans.

While a recent agreement between Washington and Beijing has temporarily slashed some duties for 90 days, considerable uncertainty remains about the final scope of tariffs and the policy responses of other nations.

Australia, a major exporter of resources to China, is particularly vulnerable to disruptions in global trade. Tariffs on the world’s second-biggest economy could hinder its growth and, consequently, its demand for commodities like iron ore.

The RBA’s quarterly Statement on Monetary Policy indicated that inflation would be lower and unemployment higher due to the cascading effects of global trade tensions. It specifically warned that the drag from Trump’s tariffs would lower global growth and prove disinflationary for Australia in net terms.

Mixed domestic picture

Domestically, the data flow has been mixed. While the anticipated rebound in consumer spending has been disappointingly low, the labour market has remained strong, with the jobless rate hovering around a low 4.1 per cent for over a year. Wage growth picked up in the first quarter, though this was primarily attributed to government pay rises rather than a damaging wage-price spiral.

Despite the rate cut, the RBA remains attentive to domestic economic activity and inflation uncertainties. The RBA’s staff forecasts now project underlying inflation to ease slightly more quickly to be around the mid-point of its 2-3 per cent target range throughout much of the forecast period, while the labour market is seen loosening a tad. These forecasts assume a cumulative 85 basis points of easing by mid-2026.

The RBA has adopted a delicate balance in its monetary policy, seeking to hold onto labour market gains while curbing inflation. With core inflation returning to target and unemployment remaining low, this approach appears to be yielding results.

However, the Board acknowledged the uncertainties, including the lags in the effect of monetary policy and how firms’ pricing decisions and wages will respond to the demand environment and weak productivity outcomes amidst a tight labour market. The RBA concluded that while the risks to inflation have become more balanced, it will remain data-dependent and vigilant in guiding its future decisions, focusing on its mandate to deliver price stability and full employment.

(With inputs from agencies)