Lower rates aim to revive fragile economic momentum
The Reserve Bank has lowered the official cash rate (OCR) to 2.25%, delivering a widely expected 25-basis-point cut as it works to support a fragile economic recovery and guide inflation back toward the midpoint of its target band.
The move was confirmed in Wednesday’s Monetary Policy Statement (MPS) and marks outgoing Governor Christian Hawkesby’s final decision before Anna Breman takes over on 1 December. Her first influence on policy will come in February.
The Monetary Policy Committee (MPC) said annual consumers price inflation lifted to 3% in the September quarter but remains on track to fall to around 2% by mid-2026, supported by significant spare capacity in the economy and the cumulative 300 basis points of easing delivered since August 2024.
“Future moves in the OCR will depend on how the outlook for medium-term inflation and the economy evolve,” the statement said.
Inflation easing beneath the surface
The MPC noted ongoing declines in core and non-tradables inflation, even as headline CPI was temporarily pushed higher by petrol, food and household energy costs.
“Annual headline CPI inflation increased due to higher tradables inflation… As these dissipate, this will support headline CPI inflation returning to near the 2% mid-point of the target range in mid-2026,” the record of meeting said.
Household inflation expectations have eased but remain elevated relative to recent history, while professional forecasters’ expectations remain “slightly above” the 2% midpoint.
Weak mid-2025 data overstated downturn
The committee said the 0.9% GDP fall in the June quarter likely overstated the true weakness in activity, citing an unusually large seasonal balancing item that is expected to reverse over subsequent releases.
Geopolitical uncertainty – including US tariff changes – had also weighed on business and household behaviour, delaying investment and spending.
Sector-specific issues added pressure. High milk prices and weather impacts lifted livestock retention, suppressing meat production, while elevated energy prices weighed on manufacturing.
Spare capacity widens as labour market softens
Economists and brokers will note the MPC’s assessment that significant spare capacity remains across the economy. Unemployment and underutilisation have risen, vacancies have declined, and firms report it is now “relatively easy” to find workers.
Potential output growth is estimated at around 1.5%, reflecting subdued gains in productivity and a slowing working-age population.
Weak labour demand has also driven elevated net outward migration, particularly to Australia, though the Committee expects this to moderate as domestic conditions stabilise.
Financial stress easing as mortgage rates fall
Lower mortgage rates and a softer currency have eased domestic financial conditions. The average mortgage yield has fallen to 5.4%, with nearly 40% of fixed loans due to reprice over the December and March quarters.
Based on current market pricing, the average mortgage yield is expected to fall to 4.7% by September 2026.
“Non-performing housing loans have also declined, and banks expect further reductions in housing and commercial property impairments over 2026,” the MPC said.
Business loan impairments remain elevated but still below levels experienced in prior downturns.
Early signs of recovery emerging
Near-term indicators suggest conditions improved slightly through Q3, with stabilising labour demand, better job-vacancy trends, and modestly stronger business feedback pointing to a return to positive GDP growth in the September quarter.
High export prices continue to support rural incomes, although farmers remain focused on debt reduction rather than investment.
House prices remain stable despite cheaper mortgage rates, which the Committee says may reflect weak population growth, elevated long-term rates, and supply-side reforms reducing price pressures.
The upcoming loosening of loan-to-value (LVR) restrictions is not expected to materially alter price dynamics due to debt-to-income (DTI) caps now in place.
Balanced inflation risks and a cautious outlook
The MPC said inflation risks are evenly balanced. Upside risks include faster-than-expected margin rebuilding by businesses and stronger-than-assumed household spending. Downside risks include prolonged household caution and slower migration-driven population growth.
Global uncertainty – including slowing AI-related investment, China’s soft domestic demand, and US policy unpredictability – also weighs on the outlook.
Why the OCR was cut to 2.25%
The committee considered holding the OCR at 2.5% but ultimately voted 5–1 to cut.
Arguments against cutting focused on:
• the large amount of easing already delivered,
• improving economic indicators, and
• upside inflation risks.
Arguments for cutting highlighted:
• “significant excess capacity” across the economy,
• the need to avoid unnecessary employment volatility, and
• the importance of supporting confidence during an early-stage recovery.
The committee concluded that lowering the OCR would help underpin demand and guard against the risk of a slower-than-desired recovery.
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