New inflation data from the Australian Bureau of Statistics shows headline inflation at 4.0% for the year to May, down from 4.2% in April. However, the drop is largely due to falling petrol prices, while underlying inflation—the Reserve Bank's preferred measure—rose to 3.6% from 3.4%, keeping the door open for another rate hike.
Fuel-Driven Decline Masks Stubborn Core Inflation
The headline consumer price index (CPI) actually fell 0.1% in the month, driven by a 33% spike in petrol prices in March following the Iran war, followed by a sharp decline due to a tentative peace deal and the federal government's halving of fuel excise. But economists focus on the trimmed mean, which excludes volatile items like fuel. That measure rose to 3.6%, well above the RBA's 2.5% target.
RBA Governor Michele Bullock has repeatedly stressed that underlying inflation is the key metric. "The RBA watches the trimmed mean closely because it gives a clearer picture of domestic price pressures," said economist Saul Eslake. "A lower headline driven by petrol does not signal sustained progress."
Homegrown Services Inflation Persists
Inflation is now split between tradeable goods (like petrol, phones, and cars) whose prices are set globally, and non-tradeables (rent, insurance, health, education, dining out) that depend on local demand and wages. The latter continues to rise strongly: rents up 3.6%, insurance up 5.5%, health up 3.8%, education up 4.8%, and eating out up 4.0%.
This domestic inflation is exactly what interest rates are designed to combat. "When inflation is homegrown, a temporary petrol discount does nothing to solve it," said AMP Capital chief economist Shane Oliver. "The RBA needs to see sustained cooling in services inflation before considering rate cuts."
Temporary Relief, Persistent Risk
The petrol price relief is temporary on both fronts: global oil prices could spike again, and the fuel excise cut is being wound back. This will push headline inflation back up in coming months. The RBA held the cash rate at 4.35% last week after three hikes this year, but warned it stands ready to act again if underlying inflation does not ease.
Financial markets are not pricing in rate relief soon. "The underlying measure has been flashing the same warning all along," noted Eslake. "Until domestic demand cools, the RBA's next move could still be up."
