Australian CPI beats expectations at 4%, but core inflation sends a hawkish signal

Australia’s May inflation report provided something for both doves and hawks. On the surface, the numbers look encouraging. Core CPI fell by -0.7% m/m and annual inflation slowed from 4.2% m/y to 4.0% m/y, both below market expectations. Much of this improvement came from the collapse in fuel prices, as motor fuel costs fell -11.9% during the month after a -7.0% decline in April. The decline in global oil prices and the government’s reduction in fuel taxes have combined to provide a strong push to reduce inflation.

But the deeper story was much less reassuring. The Reserve Bank of Australia’s preferred average measure rose 0.4% month-on-month, beating expectations. Low average annual inflation accelerated from 3.4% y/y to 3.6% y/y, reaching the highest level since late 2024. In other words, the decline in headline inflation was largely driven by energy-related factors rather than an easing of broad domestic price pressures. This distinction is important because policymakers focus on whether core inflation has become embedded in the economy.

The dichotomy between goods and services inflation highlights the challenge. Goods inflation fell from 4.7% year-on-year to 4.2% year-on-year as lower fuel prices affected the economy. Services inflation moved in the opposite direction, accelerating from 3.5% y/y to 3.7% y/y. Housing was the biggest contributor to overall inflation, rising 6.5% year-on-year, while food and transport costs also remained high.

The report is unlikely to provide a definitive answer on whether the Reserve Bank of Australia has finished tightening or not. Instead, it reinforces the central argument facing policymakers: overall inflation is moving downward, but the underlying inflation problem has not yet shown convincing signs of abating.

The full Australian CPI release is here.