Interest rate hikes remain on cards as underlying inflation climbs, economists warn

Despite plunging fuel prices, trimmed mean inflation increased from an annual pace of 3.4% to 3.6%

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Australia’s inflation challenge is far from over and more Reserve Bank rate hikes remain on the cards , economists warn, even after a plunging petrol costs drove an unexpected fall in consumer price growth in the year to May.

Annual inflation dropped to 4%, from 4.2% in the year to April, according to the Australian Bureau of Statistics, dragged down in large part thanks to a nearly 12% drop in fuel prices in the month of May.

The consensus view among experts had been for inflation to accelerate to 4.4%; but the flattering “headline” result masked a further lift in underlying price pressures.

The ABS’s trimmed mean measure of inflation – which is preferred by the RBA as it removes large, temporary price swings – climbed to 3.6% in the year to May, from 3.4% the month before.

Jim Chalmers welcomed the lower headline rate of inflation, even as he said his government was not “complacent” about the risks .

“We know that there are still inflationary pressures in our economy. But these numbers today are much better than the market expected, much better than forecast, and that’s obviously a very good thing,” the treasurer said.

Evidence that higher fuel costs were being passed through the supply chain was apparent in the 0.9% increase in home building costs in the month of May, which was the most since late 2022.

That lifted the annual pace to a very strong 5.6%, the ABS figures showed.

Food and drink inflation also accelerated to 3.3% in the year to May, versus 2.8% in April. That included a 4% increase in restaurant and takeout meals.

The mixed messages from the consumer price report left interest rate predictions largely unchanged.

The probability of a rate hike on 11 August, according to financial markets, inched up to a 32% chance, while the chance of an increase by the end of this year remained at 56%.

Sally Auld, the chief economist at NAB, said Wednesday’s price report suggested headline inflation would peak well below the 5% rate predicted in the federal budget for the year to June.

Auld’s said “at the margin, the pressure to take interest rates higher isn’t as compelling”. She predicted the next move in rates would be a down – although mortgage relief would not arrive for another year.

“This lower inflation print combined with further evidence the economy is slowing a bit more than thought means the RBA may take a less hawkish tone when they next meet,” she said.

But Shane Oliver, AMP’s chief economist, said the fact that underlying inflation had come in a little hotter than expected in May had reinforced his expectation that the RBA would hike for a fourth time in August.

Oliver said the central bank was worried about not acting soon enough to prevent a high inflation psychology taking hold.

“There’s probably still more impact to come to food prices from higher fertiliser prices, and that’s going to worry the RBA,” he said.