Westpac expects the Reserve Bank of Australia (RBA) to raise interest rates again in May, marking a dramatic reversal from expectations of rate cuts just six months ago. The bank's chief economist, Luci Ellis, outlined the forecast citing persistent inflation and stronger-than-expected demand growth as key factors driving the change in the monetary policy outlook.
"We currently expect one more rate rise, in May," Ellis said in the report.
The RBA raised the cash rate to 3.85% at its February meeting after inflation increased in ways that were not apparent or expected in mid-2025. Westpac believes the central bank remains dissatisfied with the inflation trajectory and will need to tighten policy further.
Ellis noted that overall demand growth has been more positive than anticipated, with prices responding sooner than volumes when demand surprises. Above-average inflation in many administered prices has compounded the problem.
The bank does not expect the data flow to soften soon enough to prevent the May rate increase. Even if the labour market weakens unexpectedly, that development would not occur quickly enough to affect the May decision, according to the analysis.
While a March rate hike remains possible, Westpac considers it less likely. The RBA has indicated that much of the recent increase in inflation is temporary, which reduces the urgency of back-to-back rate rises.
"It is clear both from the post-meeting communication and today's testimony before the House of Representatives that the RBA thinks that '[m]uch of the increase in inflation is judged to be temporary' and only some of it is persistent," the report stated.
Beyond May, Westpac believes an extended period of rates on hold at a restrictive stance is more likely than further increases. The bank expects a downward trajectory in underlying inflation to emerge and become evident in second-quarter data.
Ellis highlighted the role of the exchange rate in shaping the inflation outlook. The Australian dollar has strengthened noticeably since the previous forecast round, which could slow overall inflation sooner than RBA forecasts suggest through lower prices for imported consumer goods.
"Pass-through of lower prices of imported goods through to retail prices could slow overall inflation noticeably," the analysis stated.
The shift represents a significant turnaround in Australia's interest rate outlook over the past six months.