Rate rise remains a risk as key measure on inflation hits two-year high

A fourth interest rate hike on a slowing property market remains in play after new figures revealed underlying inflation pressures are broadening across the economy despite a sharp drop in petrol prices over the past month.

Data from the Australian Bureau of Statistics showed prices fell by 0.7 per cent in original terms, taking annual headline inflation down to 4 per cent. It had jumped to 4.6 per cent in March as fuel prices soared due to the start of the war against Iran and the closure of the Strait of Hormuz.

But in a concern for the Reserve Bank, which after lifting interest rates at its first three meetings of the year held steady last week, both measures of underlying inflation lifted by 0.4 per cent in May, taking them 3.6 per cent. Underlying inflation is back to its highest level since September 2024.

Headline inflation is running much lower than either the Reserve Bank or the federal government had expected. In last month’s budget, Treasury forecast that inflation would reach 5 per cent by the end of the financial year, while the RBA was expecting it to hit 4.8 per cent.

The Reserve, however, is more focused on underlying inflation, which excludes unusual price falls or increases in a bid to give a better indication of broad price pressures across the economy.

Treasurer Jim Chalmers highlighted the steep fall in overall inflation but acknowledged price pressures were still evident.

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

But Liberal leader Angus Taylor said inflation was being driven by the government’s own actions.

“Labor’s wasteful spending is fuelling core inflation. Labor’s taxes are punishing aspiration, and Australians have suffered the worst collapse in living standards in the developed world,” he said in question time.

According to the bureau, fuel prices fell by 11.9 per cent in May following a 7 per cent drop in April that occurred after the federal government halved petrol excise. Prices have also fallen due to the large inventory of unleaded petrol in the country and the easing in the global price.

The price of Brent crude eased to $US76 a barrel on Wednesday, its lowest point since the third day of the war against Iran when it was at $US77 barrel. That suggests further easing in Australian bowser prices through June.

There were falls in prices for other goods and services. The cost of clothing and footwear fell by between 0.1 per cent and 5.5 per cent, while prices for domestic travel tumbled by more than 12 per cent.

Housing-related costs continue to be an inflation hotspot.

Electricity prices are up 21.1 per cent over the year, due to the end of federal and state government subsidies. New dwelling construction costs have climbed by 5.6 per cent over the year, while rents have lifted by 3.6 per cent.

The cost of home construction climbed by 0.9 per cent in May, partially due to the flow-on effect of the war in Iran. Costs have now climbed for three consecutive months.

Rent inflation lifted to 3.6 per cent in May after being flat in April. Despite the increase, it is still well down on the 5.2 per cent it was running at this time last year.

Before the figures, financial markets put the chance of an interest rate rise by year’s end at 50-50, with most expecting the RBA to start cutting rates by November next year. While a cut is still expected in late 2027, the chance of a rate rise this year has lifted.

Marex Australia chief economist Ivan Colhoun said the lift in underlying inflation was being driven in part by the flow on of higher transport and building costs caused by the Iran war.

But there were also signs that the price increases linked to the war could unwind relatively quickly, which would reduce the pressure on the Reserve Bank to lift rates.

“My expectation remains that a large part of the Middle East inflationary surge will reverse in coming months provided oil prices continue to normalise, which seems likely but is of course very conditional on Middle East developments, particularly the actions of Israel,” he said.

But AMP economist My Bui said underlying inflation had consistently trended up over recent months with the most recent figures suggesting price pressures were now “leaking” into the overall economy.

She said higher food, insurance and maintenance costs were all signs that inflation was not under control.