The Reserve Bank of Australia raised the cash rate target by 25 basis points to 4.35% after its May meeting, in a decision reached by majority and in line with expectations. Governor Michele Bullock said the rise is intended to contain inflation pressures and reduce the risk of second-round effects feeding into expectations.
Bullock said the cash rate is now a bit restrictive and gives the Bank scope to respond as conditions evolve. She said the oil shock is a real-income hit and worsens the trade-off between inflation and growth, with costs expected to build through the year even if conflict ends quickly.
Policy Signals And Inflation Risks
The Bank said it will monitor data and shifting risks, noting a somewhat constrained labour market and falling confidence surveys that are only loosely linked to activity. It warned of possible physical shortages of oil products and said higher fuel costs may spread into wider goods and services prices, while some firms have not yet passed on cost rises.
Forecasts include GDP of 1.9% in Q2, 1.3% in Q2 2027 and 1.4% in Q2 2028, with unemployment at 4.2% in Q2 and 4.7% by Q2 2028. CPI is forecast at 4.8% in Q2, 4.0% in Q4, 2.4% in Q2 2027 and 2.5% in Q2 2028, while trimmed mean inflation is seen at 3.8% in Q2, 3.5% in Q4, 3.1% in Q2 2027 and 2.5% in Q2 2028.
Market pricing referenced 60 bps more tightening to 4.7%, with Brent forecast at $82.3 by year-end and $75.7 at end-2027. After the decision, AUD/USD was down 0.06% at 0.7162.
The Reserve Bank of Australia did what we expected, raising the cash rate to 4.35%. We are being told this hike gives the board space to see how the ongoing conflict and oil shock play out. This means policy is now highly reactive, creating opportunities in the weeks ahead for traders who watch the right signals.
We see the RBA as being in a hawkish holding pattern, ready to act on any sign that inflation is becoming embedded. This puts immense focus on the next monthly CPI indicator from the Australian Bureau of Statistics, which will be the first major data point following this decision. Options traders should consider pricing in higher volatility around that release, as a high print would almost certainly trigger bets on another rate hike at the next meeting.
Fx And Rates Trading Implications
For the AUD/USD, the situation creates a tug-of-war between a hawkish central bank and global risk aversion pushing capital towards the US dollar. This suggests the pair could remain caught within a range, possibly between 0.7090 and 0.7270 in the near term. Selling volatility through options strategies could be effective, as long as there are no major escalations in the Middle East conflict.
The main driver for RBA policy is now the price of oil, which is directly tied to the war. With Brent crude having spiked above $95 a barrel in recent months, a level not seen since late 2024, any further sustained move towards $100 will force the RBA’s hand. Derivative positions should therefore be sensitive to oil price movements, as they are the clearest leading indicator for future rate decisions.
The RBA’s own forecasts point to a slowing economy, with GDP growth weakening and unemployment expected to rise to 4.7% by 2028. This tension between fighting inflation now and facing slower growth later suggests the Australian yield curve will continue to flatten. We can look to trade this by anticipating that short-term bond yields, like the 2-year, will remain elevated while longer-term 10-year yields may fall on recession fears.
