RBA Reduces Cash Rate to 3.85%

• Cash Rate: Reduced by 25 basis points to 3.85%
• Reasoning: Moderating inflation, stable global conditions
• Forward Guidance: Neutral stance; no commitment to further easing
• Market Outlook: One to two additional cuts possible in 2025
• Next Meeting: Scheduled for June 2025

20th May, 2025

Reserve Bank of Australia Reduces Official Cash Rate by 25 Basis Points to 3.85%

The Reserve Bank of Australia (RBA) has lowered the official cash rate by 25 basis points to 3.85%, in line with broad market expectations. The decision was announced following the second meeting of the newly constituted interest rate setting board and marks the first monetary policy move since the re-election of the Albanese Government with an expanded lower house majority.

This is the RBA’s second rate cut in 2025 and the first time the cash rate has fallen below 4% in nearly two years.

RBA Statement “Inflation to Moderate”

Inflation in Australia has eased significantly since its peak in 2022, supported by higher interest rates working to “bring aggregate demand and supply closer towards balance.”

The March quarter data confirmed continued disinflation, with annual trimmed mean inflation falling to 2.9%, marking the first time it has dipped below 3% since 2021. Headline inflation also remained contained at 2.4%, staying “within the target band of 2–3 per cent.”

Looking ahead, the Reserve Bank’s staff forecasts suggest that “headline inflation is likely to rise over the coming year to around the top of the band as temporary factors unwind,” but underlying inflation is “expected to be around the midpoint of the 2–3 per cent range throughout much of the forecast period.”

RBA Statement “The Outlook Remains Uncertain”

The outlook remains uncertain, with the Reserve Bank noting that “uncertainty in the world economy has increased” and that financial market volatility “rose sharply for a time” over the past three months. Although recent tariff announcements have lifted market sentiment, “there is still considerable uncertainty about the final scope of the tariffs and policy responses in other countries,” while “geopolitical uncertainties also remain pronounced.”

These factors are expected to weigh on global activity, particularly if firms and households “delay expenditure pending greater clarity on the outlook,” contributing to a weaker domestic outlook for growth, employment, and inflation. Domestically, “private domestic demand appears to have been recovering” as real incomes rise and financial stress eases, but many businesses report “weakness in demand makes it difficult to pass on cost increases.”

Labour market conditions remain “tight,” with low underutilisation and ongoing employment growth, though “wages growth has softened” and productivity remains weak, resulting in “high” unit labour cost growth. The Bank highlighted that “the pick-up” in consumption may be slower than previously expected, and warned of risks to demand and the labour market if consumption remains subdued. At the same time, it acknowledged the potential for stronger labour outcomes, depending on incoming data. More broadly, the RBA flagged uncertainty about “the lags in the effect of monetary policy” and how firms and workers will respond to “the demand environment and weak productivity outcomes” amid ongoing labour tightness.

RBA Statement “Maintaining low and stable inflation is the priority”

The Board judged that “the risks to inflation have become more balanced,” with inflation now “in the target band” and upside risks appearing to have diminished as global developments are expected to dampen economic activity. With inflation forecast to remain near target, the Board concluded that “an easing in monetary policy at this meeting was appropriate” and assessed that this would make policy “somewhat less restrictive.” However, the Board remains cautious, citing the “heightened level of uncertainty about both aggregate demand and supply,” and considered a severe downside scenario, noting that “monetary policy is well placed to respond decisively” should global events materially affect Australian activity or inflation.

Going forward, the Board emphasised it would remain “attentive to the data and the evolving assessment of risks” and will closely monitor developments in the global economy, financial markets, domestic demand, inflation, and the labour market. Reaffirming its commitment to its core mandate, the Board stated it “will do what it considers necessary” to achieve “price stability and full employment.”

Market Expectations and Guidance

Financial markets had priced a 25 basis point reduction with near certainty ahead of the meeting. Economists were largely in agreement, although a minority argued for a hold, and a few suggested the possibility of a 50bp cut. The central bank’s action is consistent with its February guidance, which implied a neutral cash rate is likely in the vicinity of 3.5%.

The current rate path is seen as a move toward that neutral setting, with forward rate markets now factoring in one to two further cuts by year-end. However, the RBA stopped short of providing any commitment to further easing, reinforcing a data-dependent approach.

Policy Framework and Lag Effects

The RBA’s approach continues to reflect a post-2018 shift away from forward-looking monetary policy. As highlighted by recent analysis published in The Australian Financial Review, the correlation between the RBA’s cash rate changes and leading economic indicators has weakened considerably since 2018, suggesting a lagged, reactive stance to monetary developments. Adjusted for an 18-month delay, this correlation improves, indicating that the RBA is responding to realised rather than forecast conditions.

Given the typical monetary transmission lag of 12 to 18 months, the effectiveness of this approach remains under scrutiny.

Future Outlook

With the OECD leading indicator for Australia having turned positive in late 2024, and signs of domestic economic recovery emerging, the window for further rate reductions appears limited. Unless external shocks—such as renewed global trade tensions—re-emerge, current conditions suggest monetary policy may shift to a holding pattern, with upside risks to the rate path in 2026.

Read the official RBA Statement.