The defining issues of the past month centre on further tightening in economic conditions and a series of proposed tax amendments to negative gearing and capital gains tax. Worryingly, the unemployment rate climbed to a four and half year high of 4.5 per cent.
The Federal budget delivered a policy package that saw a slight tightening with a series of spending cuts and tax changes marginally outweighing the areas of additional spending. That said, the budget remains in deficit in the next four years out to FY2029-30 although the deficits are relatively small at approximately 1 per cent of GDP.
Housing remains a policy priority, with the budget adding to previous housing reforms with significant changes to regulations, lower building approval costs for builders and a roll out of housing related infrastructure. These will favour additional building in the years ahead.
In May, the RBA hiked interest rates for the third time in 2026, taking the cash rate to an equal 14 year high of 4.35 per cent. The RBA is tilting its policy approach to getting inflation lower in a more timely manner and it has signalled, via its forecasts, that it is willing to tolerate a period of weaker economic growth and higher unemployment to achieve that.
The Middle East war and related disruptions to the oil market remain a concern for the global economy. It remains a highly fluid situation.
Another important economic development is further weakness in house prices. Falls in house prices are continuing in Melbourne and Sydney, while price growth is cooling in other cities. At a national level, house prices are likely to register a fall in May.
Economic conditions globally remain fickle. Like the RBA, most central banks are poised to hike interest rates to tackle the inflation risks, even if a series of key economic indicators, the unemployment rate in particular, are pointing to economic weakness.
Key data
Below is an update of key trends in the economy over the past month:
- Based on the monthly CPI, annual inflation jumped to 4.6 per cent in March, to be well above the RBA 2 to 3 per cent target. Approximately 1.5 percentage points of the annual increase was due to prices increases in areas largely outside the control of the RBA – tobacco up 11.2 per cent; petrol up 24.2 per cent and electricity up 25.4 per cent. Electricity is still being impacted by the ending of the subsidies on 31 December 2025. Trimmed mean, or underlying inflation, was steady at 3.3 per cent.
- Wages growth remains in check. The wage price index rose 0.8 per cent in the March quarter for an annual increase of 3.3 per cent. The annual increase has been in a narrow 3.25 to 3.5 per cent pace for the past year and a half although there appears to be a bias to the down side in the period ahead as labour market conditions soften.
- Household spending remains volatile with the sharp 1.6 per cent rise in March impacted by a surge in petrol purchases as householders topped up their cars amid the oil shock and fears of shortages. Excluding petrol, household spending rose 0.9 per cent. In real terms, household spending rose 0.7 per cent in the March quarter to be 2.8 per cent higher than a year earlier.
- Employment fell by 19,000 in April with falls in both full time and part time jobs. The unemployment rate rose to 4.5 per cent, the highest since November 2021 and up from the low of 3.4 per cent in 2022. The number of job vacancies remains subdued pointing to further increases in the unemployment rate over the medium term.
- Consumer sentiment remains weak and is around the low point of the COVID pandemic. Both the Roy Morgan – ANZ and the Westpac-Melbourne Institute index of consumer sentiment have fallen sharply in the wake of RBA interest rate hikes and petrol shock. Consumer sentiment is a leading indicator of household spending.
- There remains extreme monthly volatility in the number of new dwelling building approvals. That said, the chart below shows a strong uptrend which is pointing to a favourable year for new dwelling construction activity. Further increases in construction will add to supply in the medium term.
- The slump in the export sector is undermining domestic economic conditions. Since peaking at a monthly level of $55 billion in 2022, goods exports have fallen to monthly average $45 billion. This represents a loss of income which risks compounding the broader downturn in the domestic economy.
RBA monetary policy and the current market pricing for the cash rate
After the May interest rate rise from the RBA, market pricing has consolidated to the point where the peak in the cash rate is seen to be near. After the budget on 12 May, markets were pricing in a peak cash rate around 4.70 per cent, approximately 35 basis points above the current 4.35 per cent. The subsequent weak labour data saw a repricing, with just one 25 basis point hike now priced in.
The RBA has given no concrete forward guidance on the path for future interest rate increases and instead has stated that it will react to incoming news from the global economy and on inflation, the labour market and economic growth in Australia. This task will be complicated by the geopolitical developments including the price and supply of oil.
Around the world, there is a view that interest rate increases will be seen in the bulk of G10 countries in the months ahead, with the notable exception of the US. The timing and extent of those rate increases remains open to debate and like in Australia, the interplay of inflation and unemployment will be critical in the outcome.
House prices
There are clear signs of a slowing in house prices, with risks building of a broader fall in prices at a nationwide level. After a tepid rise of 0.2 per cent in April, the high frequency data from Cotality are pointing to a slight fall in prices in May with Melbourne and Sydney prices dropping and the other cities registering notable slow downs. A combination of broader economic ructions, cost of living pressures, a lift in new listings for sale, a moderation in demand and borrowing capacity are all impacting.
The range of policy measures announced in the Budget are likely to act to further dampen house prices in the short to medium term.
The following chart shows the trend in house prices up to and including 14 May 2026. The slower trend is clear for the average of Sydney, Melbourne, Brisbane, Adelaide and Perth.
After a pick-up in rents towards through to the early months of 2026, the growth in rents for both houses and units is topping out but this is subject to a change in trend as the housing measures in the budget take effect. That said, rental vacancy rate remains low but has edged marginally higher in most cities.
Stephen Koukoulas is Managing Director of Market Economics, having had 30 years as an economist in government, banking, financial markets and policy formulation. Stephen was Senior Economic Advisor to Prime Minister, Julia Gillard, worked in the Commonwealth Treasury and was the global head of economic research and strategy for TD Securities in London.
