Domestic inflation remains a significant concern for the Reserve Bank of Australia (RBA) as it prepares for its upcoming board meeting to assess monetary policy. Despite an appreciating Australian dollar helping to moderate headline inflation, underlying local cost pressures continue to pose risks that could influence future interest rate decisions.

The Australian dollar has strengthened by nearly 9 percent since the beginning of the year, making imports cheaper and consequently tempering headline inflation figures. This currency appreciation has contributed to lowered market expectations, with the probability of a 0.25-percentage-point rate hike by the end of the year now estimated at around 40 percent. Against this backdrop, the RBA is widely expected to maintain current interest rates in the near term.

However, economists caution that headline inflation masks persistent domestic inflationary pressures, particularly in the non-tradeable sector where local factors drive up prices. Anthony Malouf, chief economist at currency risk manager Ebury, pointed to ongoing inflation in non-tradeable goods and services, which has remained elevated at 4.9 percent year-on-year and around 5 percent on a three-month annualised basis. Malouf described this trend as a key risk that may keep the RBA relatively hawkish and open to further rate increases.

Housing inflation adds to these domestic cost pressures. Costs associated with building new homes rose by 5.8 percent over the past year, marking the highest growth since mid-2023. Since new home construction expenses carry the largest weighting in the consumer price index (CPI), rising costs in this area weigh heavily on inflation measures.

Labour market dynamics also remain crucial to the RBA’s assessment. Alex Joiner, chief economist at IFM Investors, highlighted the significance of a tight labour market as a channel preserving domestically generated inflation through wage growth, service pricing, and inflation expectations. Joiner emphasized that the interest rate cycle should not be considered complete while these inflationary channels remain active. He argued that the RBA’s objective extends beyond merely bringing the trimmed mean CPI back into its target band of around 2.5 percent; the central bank must also ensure domestically driven inflation consistently falls within a 2 to 3 percent range to sustain price stability once monetary policy is eased.

Paul Bloxham, chief economist at HSBC, projected a gradual slowdown in economic growth accompanied by further cooling in the housing market and a loosening labour market, which together could persuade the RBA that additional rate hikes are unnecessary. Bloxham forecasted that the RBA might begin cutting rates in the second half of 2027 if these developments materialize. Nevertheless, he acknowledged the risk that core inflation may not decline quickly enough, potentially compelling the central bank to resume tightening.

As the RBA navigates this complex inflation landscape, balancing the influences of exchange rate movements, domestic costs, and labour market conditions will be critical in determining the future path of monetary policy.