Inflation has been above target for nearly five years
Beneath Australia's modest headline inflation improvement in May lies a more stubborn reality: the measure the Reserve Bank trusts most is moving in the wrong direction, reaching its highest point since late 2024. Cheaper petrol flattered the surface numbers, but the underlying momentum of prices — shaped by freight, inputs, and agricultural costs — continues to resist the years of rate rises meant to tame it. The RBA now faces the perennial dilemma of central banking: the economy is slowing, households are cautious, yet the deeper fire has not gone out.
- Headline inflation fell to 4% in May, but the improvement was almost entirely the gift of cheaper petrol — a volatile factor the RBA cannot count on.
- Trimmed mean inflation climbed to 3.6%, its highest since September 2024, signalling that persistent cost pressures in supply chains and agriculture are still working their way through the economy.
- The RBA's preferred inflation measure has now sat above its 2.5% target for nearly five years, leaving the central bank caught between the risk of overtightening a slowing economy and the risk of letting inflation entrench further.
- Economists are divided: some see another rate rise as likely, others warn that hikes already delivered — combined with weakened confidence — could tip Australia into recession before the year is out.
- A potential resolution hinges on forces largely outside the RBA's control — whether Middle East tensions ease, whether oil prices hold below their May peak, and whether the restoration of the fuel excise erases the relief consumers briefly felt at the pump.
Australia's May inflation data handed the Reserve Bank a puzzle with no clean answer. The headline number improved — consumer prices rose 4 per cent annually, down from 4.2 per cent — but almost entirely because petrol got cheaper, with automotive fuel prices falling nearly 12 per cent as global oil markets eased. Strip that away, and the picture darkens.
Trimmed mean inflation, the RBA's preferred measure of underlying price momentum, rose to 3.6 per cent in May from 3.4 per cent in April — the highest reading since September 2024. Unlike fuel prices, which swing with geopolitical events, this measure reflects the slower-moving pressures of input costs, freight, and agricultural goods still filtering through supply chains. Deloitte Access Economics partner Stephen Smith called the data an unwelcome reminder that Australia's inflation battle is far from over, flagging another rate rise in 2026 as likely even as the economy slows and households grow cautious.
Economists offered competing readings of what comes next. Oxford Economics Australia's Harry Murphy Cruise emphasised the lag effect — higher upstream costs will keep flowing into consumer prices for months, regardless of what oil does. But he also noted that easing geopolitical tensions in the Middle East could allow oil prices, which peaked near US$120 per barrel in May, to keep falling — they had already dropped below US$80 by late June.
BetaShares chief economist David Bassanese raised a darker possibility: that the rate rises already in place, combined with the confidence shock from the federal budget, could push Australia into recession by year's end — solving inflation through pain rather than precision. BNY's Wee Khoon Chong took a middle path, suggesting the RBA may still need to act depending on how the data evolves. Complicating the outlook further, the government's planned restoration of the fuel excise means consumers are unlikely to hold onto the petrol savings that made May's headline number look reassuring in the first place.
Australia's inflation picture in May presented the Reserve Bank with a puzzle that defied easy answers. Headline inflation, the number most people hear about, actually improved—consumer prices rose 4 per cent annually, down from 4.2 per cent the month before. The reason was straightforward: petrol got cheaper. Automotive fuel prices fell 11.9 per cent in May as global oil markets eased, and that single factor was enough to pull the headline number down.
But beneath that surface improvement lay something more stubborn. Trimmed mean inflation, the RBA's preferred lens for understanding what's really happening in the economy, climbed to 3.6 per cent in May from 3.4 per cent in April. This measure strips away the noise of volatile price swings to reveal the underlying momentum in the economy. And by that measure, Australia's inflation problem is worse than the headline suggests—the highest it has been since September 2024.
The distinction matters because it reveals what economists are actually worried about. Fuel prices bounce around based on global events and geopolitical shocks. But underlying inflation reflects something more persistent: the cost of inputs, freight, and agricultural products working their way through supply chains and into what Australians pay for goods and services. These pressures take time to fade, even after the initial shock passes.
The timing creates a dilemma for the central bank. Headline inflation has been easing, which might suggest the RBA's rate rises are working and further increases aren't needed. But underlying inflation remains stubbornly elevated—above the RBA's 2.5 per cent target for nearly five years now. Stephen Smith, a partner at Deloitte Access Economics, called the data an unwelcome reminder that Australia's inflation battle is far from over. He warned that another rate hike in 2026 remains likely, even as the economy has slowed sharply and households have grown cautious.
Economists offered competing interpretations of what should happen next. Harry Murphy Cruise from Oxford Economics Australia pointed out that the real challenge for the RBA is the lag effect: higher costs for inputs, freight, and agricultural goods are still flowing through to consumer prices, and that process will take months to complete even if oil prices stabilize. But he also noted that recent geopolitical developments suggested the Middle East conflict may be nearing an end, which could allow oil prices to keep falling from their May peak near US$120 per barrel—they had already dropped below US$80 by late June.
Other economists saw a different risk. David Bassanese, chief economist at BetaShares, suggested the RBA might actually be finished raising rates, particularly if the oil price decline continues and the geopolitical situation stabilizes. But he warned of a darker possibility: that the rate rises already implemented, combined with the hit to business and consumer confidence from the federal budget, could push Australia into recession by year's end. If that happened, it would solve the inflation problem, but through economic pain rather than careful management.
Wee Khoon Chong, an APAC macro strategist at BNY, took a middle position, suggesting the RBA might still need to lift rates again depending on how inflation evolves. The central bank faces an uncomfortable situation: headline inflation is easing, but underlying inflation is rising. The economy is slowing, but price pressures remain. Oil prices are falling, but the government is about to restore the fuel excise, which means consumers won't see the full benefit at the bowser. The RBA's next move will depend heavily on whether the recent improvement in geopolitical conditions holds and whether oil prices stay down.
Notable Quotes
Today's CPI data is an unwelcome reminder that Australia's inflation problem is not yet solved, with another rate hike in 2026 still likely.— Stephen Smith, Deloitte Access Economics
Higher input, freight and agricultural costs are still passing through to consumer prices, meaning inflation pressures will take time to fade, even after oil prices normalise.— Harry Murphy Cruise, Oxford Economics Australia
The Hearth Conversation Another angle on the story
Why does the RBA care so much about underlying inflation when headline inflation is actually improving?
Because headline inflation can be misleading. A drop in petrol prices looks good on the surface, but it's temporary—it's driven by global events, not by the health of the Australian economy itself. Underlying inflation strips that away and shows what's actually happening in the real economy: how much businesses are paying for inputs, how much it costs to move goods around, how much farmers are struggling. That's the persistent pressure.
So the RBA is worried about something that most Australians won't notice in their weekly shopping?
Exactly. Most people see petrol prices fall and think inflation is solved. But a baker is still paying more for flour and energy. A transport company is still paying more to move goods. Those costs eventually show up in the price of bread, milk, and everything else. The RBA is trying to stop that cascade before it gets worse.
But if the economy is slowing and people are being cautious, why would the RBA raise rates again? Wouldn't that make things worse?
That's the dilemma. Normally, yes—you'd ease off when the economy is weak. But inflation has been above target for five years. The RBA can't just ignore that and hope it goes away. They're caught between two bad options: keep rates high and risk recession, or cut rates and risk inflation getting entrenched.
What changes the equation?
Oil prices. If they stay down and the Middle East conflict really does end, then the input costs that are driving underlying inflation will eventually ease. That gives the RBA breathing room. But if oil spikes again, or if the conflict drags on, then those cost pressures keep flowing through the economy and the RBA has to keep rates high.
So Australia's inflation problem is really a global problem?
It's become one. The energy shock started overseas, and Australia's economy is still absorbing the ripple effects. The RBA can't control oil prices or Middle East politics. All they can do is manage how Australian businesses and households respond to those shocks.