Australia's central bank set to cool its heels after rapid-fire rate hikes

SYDNEY - Australia's central bank lifted rates for a third time this year on Tuesday, returning borrowing costs to post-pandemic highs and warning that inflation would remain sticky as the conflict in the Middle East unleashed a global oil shock.

Governor Michele Bullock said the board now judged monetary policy to be slightly restrictive after a burst of rate hikes this year, allowing the board to pause and gauge inflation and growth risks linked to war.

Wrapping up the May policy meeting, the Reserve Bank of Australia raised its main cash rate by 25 basis points to 4.35%, undoing all of the three rate cuts made in 2025. The board voted 8–1 in favour of the hike, a hawkish shift from March's narrow 5-4 split.

Bullock said there were early signs that firms were looking to pass through rising costs to customers, and that three rate hikes should help keep inflation expectations anchored.

"We feel we are now in a position where we have got space to be alert to both sides of the risks, the inflation and potential risks to the downside, if the war continues," she said at the post-decision press briefing.

The Australian dollar slipped 0.3% to $0.7145, while three-year government bond yields fell 5 basis points to 4.625%, the lowest in two weeks, as markets scaled back the odds of more near-term rate hikes.

Swaps imply around a 15% chance of a further move in June. An increase to 4.60% by September is about fully priced, which would be the highest since late 2011..

"Higher fuel prices are adding to inflation and there are indications that this is likely to have second-round effects on prices for goods and services more broadly," the board said in a statement.

"The board assessed that inflation is likely to remain above target for some time and that the risks remain tilted to the upside, including to inflation expectations."

Yet the RBA also emphasised that having raised the cash rate three times, "monetary policy is well placed to respond to developments," hinting it might pause for now.

Inflation had already climbed to 4.6% in March, driven by higher fuel costs, while the closely watched core measure remained uncomfortably above the RBA's 2%-3% target band.

The oil price spike triggered by the U.S.-Israeli war on Iran saw the RBA sharply raise its forecasts for inflation this year, tipping a peak near 5% while cutting the outlook for economic growth and employment.

HORMUZ RISK

"Today, the Board showed a clear preference to prioritise the price stability mandate. There is a strong message in this outcome, meaning that risks are biased towards a further adjustment in the cash rate," said Sally Auld, chief economist at the National Australia Bank.

"For now, we have the RBA on hold at 4.35%."

The RBA charted a softer course than its global peers during the post-pandemic inflation surge, prioritising hard-won gains in the labour market over rapid tightening. Interest rates peaked at 4.35% early last year before three cuts pulled them back to 3.6%.

That gamble backfired in the second half of the year as inflation reignited, a risk now supercharged by the Iran war and a fresh global energy shock. The U.S. and Iran launched new attacks in the Gulf on Monday, lifting Brent crude futures to $114 a barrel, up over 50% from pre-conflict levels.

Business and consumer confidence in Australia crashed on fears that the war may tip the economy into a recession, while the housing market has lost steam amid higher borrowing costs and geopolitical uncertainty.

The labour market remains the outlier, with the jobless rate holding at a historic low of 4.3%.

The outlook hinges on the Strait of Hormuz, a vital route for about 20% of global oil flows, which Iran has effectively closed since the war began in late February.

"By August – in the absence of a rapid resolution to the conflict in the Middle East and a resumption of oil flows – we expect the activity data in Australia to be looking sufficiently soft to keep the RBA on hold," said Adam Boyton, head of Australian economics at ANZ.

(Reporting by Stella QiuEditing by Shri Navaratnam)

Copyright Reuters or USA Today Network via Reuters Connect.

This story was originally published May 5, 2026 at 2:12 AM.