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While inflation remains above target, the latest data suggests some of the drivers behind recent price increases are beginning to ease. Annual inflation fell from 4.6 per cent to 4.2 per cent in April, with lower fuel prices helping to unwind part of the surge seen earlier in the year. However, underlying inflation remains elevated and housing continues to be the largest contributor to overall inflation.
The bigger concern for the RBA is that economic growth is losing momentum. GDP increased by just 0.3 per cent in the March quarter. Importantly, much of that growth was driven by business investment in data centres rather than broad-based strength across the economy. Household spending remains subdued, discretionary spending is weak and consumers continue to be cautious.
The labour market is also showing clearer signs of softening. Employment fell in April and the unemployment rate increased to 4.5 per cent. While unemployment remains relatively low by historical standards, conditions are no longer tightening and the direction of change is increasingly important.
Consumer sentiment remains deeply pessimistic. Although confidence improved slightly following the federal budget and the easing in fuel prices, households remain concerned about the economic outlook, job security and the impact of higher interest rates on family finances.
Housing remains one of the most difficult areas for policymakers. Inflation linked to housing continues to be driven by structural supply shortages. Construction costs remain elevated, limiting the pace at which new housing can be delivered, while rental vacancy rates remain near historic lows.
The federal budget has also fundamentally changed the outlook for rental supply. By reducing the attractiveness of residential property investment, the changes are likely to discourage investor participation at a time when rental markets are already undersupplied. The result is likely to be fewer rental properties available, tighter vacancy rates and stronger rental growth. While the budget may help moderate house price growth, it is also likely to place further upward pressure on rents.
The housing market is already responding to higher interest rates and weaker economic conditions. Sydney is now leading the national downturn, particularly at the premium end of the market where higher borrowing costs and weaker confidence are having the greatest impact.
The decision to hold reflects a Reserve Bank increasingly focused on the balance of risks. Inflation remains too high, but economic growth is slowing, unemployment is rising and confidence remains weak. With the effects of previous rate increases still flowing through the economy, the Bank has chosen to wait for clearer evidence before taking further action.