Background to the RBA decision today at 2.30pm

The Reserve Bank of Australia announces its next interest-rate decision at 2.30pm today. With the cash rate already at 4.35%, financial markets have been pricing a further 25-basis-point increase to 4.60%.

The RBA has increased interest rates three times this year, by a combined 75 basis points, before holding steady at its June and August meetings. However, recent developments have complicated the inflation outlook.

Inflation remains the central concern. Annual headline inflation eased to 3.5% in July, but underlying inflation, measured by the trimmed mean, remained at 3.6%. Housing costs rose 5.0% annually, while automotive fuel prices jumped 7.5% in July. Continuing Middle East tensions and higher energy costs present additional inflation risks.

Meanwhile, the labour market is showing signs of cooling. August unemployment reached 4.6%, with full-time employment falling by 6,300 despite total employment increasing by 39,500. Participation also increased. The ABS cautions against overinterpreting individual monthly movements.

The timing is particularly interesting. Last Tuesday, Governor Michele Bullock said unemployment between 4.5% and 5% would probably remove sufficient pressure from the labour market to help reduce inflation. Two days later, the ABS reported unemployment of 4.6%. This was an indicative assessment, not a formal unemployment target.

Economic growth is also subdued. GDP increased just 0.4% in the June quarter, while annual wages growth moderated to 3.2% and labour productivity declined 0.2% over the year.

Financial markets were pricing approximately a 95% probability of another increase on 22 September. The four major banks have also forecast a September increase.

Tomorrow's decision will reveal how the RBA weighs persistent inflation and energy-price risks against an economy already experiencing slower growth and rising unemployment. The August inflation figures, due Wednesday, will provide the next important test.