No easy path for rates

Global 

The conflict between Iran and the US was renewed in July with President Trump declaring the ceasefire over just three weeks after it began. The sticking point appeared to be Iranian efforts to enforce its control over the Strait of Hormuz with attacks on shipping triggering a forceful US response.

In the meantime, we have seen global supply chains work to realign away from the Strait and secure alternate sources of key resources. These include Saudi Arabia’s pipeline to the Red Sea as well as an emerging “dark” trade where shipments are still passing through the Strait while hiding their presence and being subjected to intermittent Iranian attacks [1]. These changes have blunted the impact of the Strait’s closure as has the release of strategic oil reserves into global energy markets. The solutions are not foolproof however and the prospect of ongoing hostilities has contributed to a rise in long-term bond yields globally in recent weeks.

In our view the Fed’s holding bias appears set to continue unless we see an acceleration in inflationary pressures with sufficient weakness in the jobs market helping justify the current holding pattern.

The conflict in the Middle East has posed unwelcome challenges on the inflation front across the world. In the US, the Federal Reserve’s preferred Core PCE inflation measure rose 3.3% for the year to June, uncomfortably above its long-term 2% target. These pressures have added to the case for rate hikes. In the Fed’s July meeting the majority voted in favour of keeping interest rates on hold with three dissenting in favour of a hike. There are some signs of inflation softening with wage growth slowing and jobs growth disappointing expectations in recent months. In our view the Fed’s holding bias appears set to continue unless we see an acceleration in inflationary pressures with sufficient weakness in the jobs market helping justify the current holding pattern.

The US economy grew 2.1% for the year to June, marking a deceleration from the March quarter. A widening trade deficit saw net exports continue to drag on the economy whilst higher fuel prices also posed a notable headwind. On the flipside however is the growing impact of investment in artificial intelligence (AI) infrastructure, which is contributing meaningfully to growth, 1% in the June quarter. This contrasts to the (still) larger contribution from household spending (1.6%) a key driver of the US economy in aggregate. The noteworthy feature here is that whilst the AI infrastructure buildout is seeing leakage in the form of heightened imports of semiconductor chips for instance it is still creating a large mix of direct and indirect tailwinds to economic growth.

Annual contribution to US GDP growth (Jun-16 to Jun-26)

Eurozone inflation ticked higher with a 2.9% increase for the year to July while underlying inflation accelerated to 2.5%. This may see the ECB act again in hiking rates.

Europe surprised positively for the June quarter with growth ahead of expectations at 0.4% for the quarter (consensus: 0.2%) and 1% for the year to June. However, Eurozone inflation ticked higher with a 2.9% increase for the year to July while underlying inflation accelerated to 2.5%. This may see the ECB act again in hiking rates.

China saw a surprising degree of weakness in the June quarter with growth for the year to June of 4.3%, below the government’s annual target range of 4.5%-5% and consensus forecasts for 4.5% growth. This comes as the country’s export performance continues to hold up well with 27% growth for the year to June, bolstered by demand for semiconductor and electric vehicle exports. Domestically, however there remain challenges with retail sales rising only 1% over the same period pointing towards weak household consumption. 

Australia

The Australian economy showed signs of resilience with household spending accelerating and still-tight labour market conditions persisting. This strength has come at a cost with inflationary pressures also becoming seemingly embedded.

July was marked by a range of key economic datapoints that pose serious questions of the Reserve Bank. Current consensus forecasts by market economists favours a holding pattern followed by rate cuts in 2028 whilst market-implied pricing suggests scope for at least one potential hike by year-end.

On the inflation front, June saw headline inflation decelerate to 3.8%, down from 4% for the twelve months to May. A 2.7% drop in transport costs, impacted by both the fuel excise cut and decline in energy prices in June, contributed sizeably to the move. The average of the less volatile trimmed mean and weighted median measures saw underlying inflation hold steady at 3.6%. This is well above the RBA’s target band of 2-3% and has persisted at these levels for over a year now casting doubt on the Board’s ability to achieve price stability.

Headline versus underlying inflation (Apr-25 to Jun-26)

The other leg of the RBA’s mandate is to promote full employment, the level of unemployment that generates steady inflation outcomes. On this front the labour market has remained unquestionably tight with unemployment at 4.4% in June and broader underemployment at 6.5%. Vacancies continue to track at reasonable levels albeit slightly softening over the past year.

Finally, household spending continues to hold up well despite the higher rate environment growing 5.5% for the year to June comprising 2.4% in volume growth and 3% in higher prices. Discretionary categories such as hospitality and recreation continue to see volume spending well above the pre-pandemic trend.

Quarterly household spending (Jun-17 to Jun-26)

Partly this reflects the strength of the jobs market with most people seeking a job being able to find it and thereby contribute to overall consumption. Recent decisions such as the 4.75% uplift in the minimum wage from July affecting almost 3 million workers further exacerbate this trend[2]. In addition, the higher rate environment is a double-edged measure with only 35% of households according to the 2021 census owning a home with a mortgage[3]. This leaves a sizeable portion of households that benefit from the higher rate environment with higher returns on savings balances and other investments such as government bonds where the rise in yields translates into higher income and spending power. This could be a factor dampening the RBA’s ability to throttle demand through rate hikes.

In summary the Australian economy showed signs of resilience with household spending accelerating and still-tight labour market conditions persisting. This strength has come at a cost with inflationary pressures also becoming seemingly embedded. This backdrop will pressure the RBA in our view although there is a reasonable prospect that Budget headwinds to credit growth with a slowing housing market coupled with geopolitical fears may see it revise its economic outlook lower and remain on hold at its next meeting.

This backdrop will pressure the RBA in our view although there is a reasonable prospect that Budget headwinds to credit growth with a slowing housing market coupled with geopolitical fears may see it revise its economic outlook lower and remain on hold at its next meeting.

Sources

[1] “Covert Mideast oil flows are keeping global prices in check”, Fortune, 16 August 2026: Covert mideast oil flows are keeping global prices in check | Fortune

[2] “Business warns 4.75pc minimum wage rise could push up inflation, rates”, Australian Financial Review, 2 June 2026: Business warns 4.75pc minimum wage rise will push up prices, inflation, interest rates

[3] “By the numbers: Australian Home Ownership & Tenancy”, Savings.com.au, 5 March 2026: Australian Home Ownership & Rent Statistics