With a new year on the horizon, all eyes are on the Reserve Bank of Australia (RBA) and the likelihood of interest rate cuts in 2025. The prevailing view is that some easing will occur, likely through two 25-basis-point (bp) cuts starting in the second quarter of 2025. However, there’s an emerging risk that the RBA could skip the easing phase altogether, leaving interest rates higher for longer.

While this is not our central expectation, we see two primary scenarios that could drive this outcome.

Scenario 1: Domestic Inflation Lingers

In the first scenario, domestic inflation could persist, proving more resilient than anticipated. The RBA has been battling inflation, but recent trends indicate it might not decline as quickly as hoped. This “last mile” of inflation reduction often proves to be the most challenging. Prices in the services sector, for example, have been notoriously sticky. As Australia heads toward a Federal election, public demand may expand, driven by election-related spending initiatives. This uptick in demand could keep prices elevated, particularly in sectors like healthcare, education, and transport, where inflation tends to be less responsive to monetary policy.

Additionally, the supply side may struggle due to weak productivity growth. Productivity plays a crucial role in balancing economic growth with inflation. Without improvement, productivity limitations could continue to hamper supply, placing further pressure on prices and making it more difficult for the RBA to justify rate cuts.

Scenario 2: A Global Economy on the Rebound

The second scenario centers on the possibility that, by the time inflation in Australia eases enough for rate cuts to be considered – which we currently project could be around six months from now – the global economy could be experiencing a reinflation phase. This would mean rising global demand, higher commodity prices, and increased pressure on Australia’s import costs, particularly in energy and raw materials.

A rebounding global economy could impact Australia’s inflation outlook, making the RBA reluctant to cut rates even if domestic inflation metrics fall within acceptable ranges. In such a case, the RBA may prioritize maintaining stability over stimulating further demand.

What Are the Odds?

While our central forecast remains that the RBA will initiate a gradual easing, with two 25bp cuts expected in 2025 starting in the second quarter, we see a growing risk that these cuts may not happen at all. There’s about a 25% chance that the RBA could choose to keep rates steady, influenced by either of the two scenarios outlined above.

The Bottom Line

As the RBA navigates the next phase of monetary policy, the complexities of both domestic inflation persistence and global economic shifts could play decisive roles. While our baseline expectation remains cautiously optimistic for a 2025 easing, the risk of no cuts at all is something investors, policymakers, and the public alike should keep in mind.