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Policy path increasingly data dependent as key activity data looms
The Minutes of the RBA’s August meeting make it clear that the door to further easing remains wide open. Should the economy evolve in line with the RBA’s forecasts, it sees the cash rate moving lower from the current level of 3.60% toward 3%. But the RBA is not committing to a pre-set path. Instead, it is closely monitoring the data, particularly inflation, the labour market and global economic conditions, to help it decide on its next move. If inflation undershoots, labour market slack emerges, or the global economy slides into recession, further easing is likely. Conversely, if inflation fails to move toward the midpoint of the target band, the labour market shows signs of tightening, or the global economy picks up, the rate cut narrative will be challenged. The central bank’s data dependence thus elevates the importance of incoming economic data.
Given this backdrop, the release of the July monthly CPI this week has raised serious questions around the RBA’s Goldilocks inflation narrative – that underlying inflation is moving gradually toward the midpoint of the target band. After several months of disinflation (falling inflation rates), the data showed a notable shift. Headline inflation rose to 2.8% in July, up from 1.9% in June. More importantly, the trimmed mean measure of underlying inflation jumped from 2.1% to 2.7%. So, what are the drivers of this inflation spike, and is it likely to be a temporary blip or the start of a persistent upward trend?
The good news is that two of the key drivers of the July inflation spike appear to be largely temporary in nature and are likely to be unwound in the August data.
The most significant was a 13% surge in electricity prices, driven partly by the delayed payment of government energy rebates in NSW, the ACT and WA. While around 5% of the increase reflected the annual rise in the default market offer, which is the benchmark for electricity pricing on the east coast and will be permanent, the bulk of the monthly jump was temporary, at least for now. Of course, the Federal government rebates are due to expire at the end of this year, which, unless extended, will push up electricity prices in 2026.
A similarly temporary dynamic played out in domestic holiday travel and accommodation, where prices increased by 7.9% in July when they would typically fall. The late timing of school holidays in several states likely contributed to this seasonal distortion. Therefore, this reflects a seasonal timing shift rather than a higher inflationary trend for the sector.
More worrying, and likely persistent, was the acceleration in the cost of new dwelling purchases by owner-occupiers, which rose 0.4% in the month. This was double the pace recorded in June and a clear shift from the declines observed through late 2024 and early 2025. This category, which accounts for 8% of the CPI, captures the cost of building new homes excluding land. It had been subdued as weak activity in the sector meant builders had to offer discounts to move inventory, thereby absorbing cost increases into their margins. With no material changes to their cost environment, the recent uptick in new home prices suggests that builders now find themselves in a position to restore margins. This change has been enabled by the improvement in demand conditions in the housing sector, supported by lower mortgage rates as the RBA cut the cash rate. With lower interest rates still feeding though to demand, and the Federal government this week announcing it will bring forward the start of the First Home Guarantee program to October, demand conditions in the housing market are likely to remain robust. With supply still facing constraints, it is possible that further margin expansion for home builders continues to put upward pressure on inflation. Trends in this sector will play a critical role in the inflation, and interest rate, outlook.
Next week’s key data release is the June quarter national accounts, which should show that the economy is gradually regaining momentum. We forecast a 0.5% increase in real GDP over the quarter, which would lift the annual growth rate to 1.6%, its fastest rate since 2023. While still below trend, this marks a clear improvement from the subdued outcomes over 2024 and suggests that the RBA’s easing cycle is gradually beginning to gain traction, with lower interest rates starting to support activity across key parts of the economy.
That said, the drivers of growth in the June quarter are expected to be relatively narrow and centred around consumption. Household spending is gradually improving, supported by better income growth, some of which is still being saved rather than spent. Government consumption is also expected to rise after a surprisingly soft March quarter. In contrast, housing investment is likely to have taken a breather in the June quarter, after rising a solid 5.6% in the year to March. Business investment and net exports are expected to make little contribution to growth in the quarter. The elevated level of global uncertainty has clearly weighed on business investment which has gone MIA, but the outlook is stabilising. The latest ABS CAPEX survey points to a 12% upgrade to firms’ 2025-26 investment intentions, driven by the services and manufacturing sectors, while mining still looks weak. A recovery in business investment will be critical to ensuring the longevity of the current cyclical upswing, as the contribution of the public sector wanes due to governments being forced by budgetary pressures to restrain spending.
Next week’s report card on the economy will offer a broader lens on how the economy is responding to the RBA’s rate cuts. But this week’s unexpected rise in July inflation deserves attention beyond the headline. While some of the spike may prove to be transitory, the risk of homegrown inflation, fuelled by policy easing already underway, is rising. If underlying inflation risks continue to build, despite the economic recovery being tepid and uneven, the RBA may find its easing bias increasingly difficult to sustain into 2026.