MNI INTERVIEW: Supply Side Concerns To Drive RBA Caution

The Reserve Bank of Australia’s recent split vote signalled Board members are likely to take a less hawkish approach than would typically be expected in response to a purely demand-driven shock, a leading Australian economist told MNI, adding that the RBA is likely to provide greater clarity on the tightening path at its May 5 meeting when it lifts rates by a further 25 basis points.

James Morley, professor of macroeconomics at the University of Sydney, said the RBA is still likely to deliver another hike but will signal awareness of potential downside risks to activity, including weaker consumer confidence and the implications for labour market conditions.

“They will signal that the pace of further rate hikes will be moderated by concern about what’s happening in the domestic economy,” he said, noting that the resilient labour market still gives the Bank room to increase rates next month.  

Markets see a 70% chance of a hike in May and a 50 basis-point increase in the cash rate to 4.6% by December.

However, Morley warned supply shocks are inherently more difficult for central banks to manage than demand shocks, because they create competing pressures between inflation control and supporting activity, which could prompt a less aggressive hiking approach. 

"Some supply shocks you might want to look through or moderate the response to the extent that you're also trading off concerns about the deterioration of the economy. The way to frame that in a reaction function sense, is that over the course of this year, the amount that they would raise would be less than if it were a demand shock." 

Drawing parallels with past oil shocks, he said the current episode is not comparable in scale to the 1970s, though it still raises the risk of higher inflation and weaker growth if it persists. While he also flagged a heightened risk of stagflation, he said a recession is not currently a danger given still-resilient labour market conditions in Australia and the U.S.

The Bank may need to hike further this year, particularly if the upcoming federal budget contains significant spending, but market participants should look for dovish language within May's communications, he said. "And I think they'll probably have some language around pace that reflects that it is a supply shock."

Morley warned of persistently strong trimmed-mean inflation prior to the RBA's initial 2026 hike in February. (See MNI INTERVIEW: Trimmed Mean Key To Feb RBA Hike)

SPLIT VOTE

Morley said he was surprised by how close the April vote was — the Board voted five-to-four to raise the cash rate. (See MNI RBA WATCH: Timing Drove Split Vote, Not Direction-Bullock)

The key policy debate within the RBA likely centres on how persistent the inflation shock will prove to be, and whether it risks de-anchoring inflation expectations. “If it’s temporary, you can look through it. But if it’s persistent, then you risk inflation expectations drifting,” he said.

Concerns over inflation expectations likely played a role in the close vote, alongside considerations of real-economy risks, he added.

Morley also noted the split vote likely reflects differing internal judgments about that trade-off between the dual mandate, with some members placing greater weight on inflation control and others on real economic conditions.

The exchange rate and upcoming fiscal developments, including the federal budget, will be important inputs into the RBA’s updated forecasts, he concluded, while cautioning that some sentiment indicators may carry limited weight in formal projections.