Reserve Bank governor Michele Bullock has put a second constraint on rate cuts into public view: productivity growth has stalled, and that narrows the path to lower borrowing costs regardless of how inflation behaves over the coming quarters. The message delivered in Sydney this week shifts attention from the consumer price index alone to the economy’s capacity to grow without generating fresh price pressure. Weak output per worker means the RBA cannot ease policy as quickly as it might if the same inflation path played out alongside stronger productivity gains.
The distinction matters because most borrowers watch the trimmed mean inflation figure and assume that once it sits inside the two to three per cent target band for a quarter or two, rate cuts follow. Productivity operates on a different channel. When output per hour worked grows slowly, any lift in demand translates more directly into higher wages and prices because the economy hits capacity constraints sooner. The RBA now treats this as a binding limit on how fast it can move, independent of the quarterly inflation print.
Why output per worker sets the speed limit
Productivity growth determines how much the economy can expand before wages and prices accelerate. Over the past two years, output per hour worked has been close to flat. That means any increase in aggregate demand, whether from consumer spending or business investment, runs into supply constraints faster than it would if productivity were growing at historical rates. The result is upward pressure on wages without a matching lift in real output, which feeds back into inflation.
The RBA’s framework assumes that if productivity stays weak, demand has to stay weaker for longer to keep inflation in check. In practice, that means higher unemployment and fewer job openings. The governor confirmed the central bank expects further easing in the labour market, which translates to a jobless rate drifting higher from the current level near four per cent. For mortgage holders, the implication is straightforward: even if inflation moderates on schedule, rate cuts will arrive more slowly if productivity does not pick up.
The inflation backdrop
Consumer price index data for May showed headline inflation at four per cent over 12 months, down slightly from the previous two months. The trimmed mean, which strips out volatile items, rose from 3.4 per cent in April to 3.6 per cent in May. That uptick keeps underlying inflation above the top of the target band, though the direction of travel since the start of the year has been downward. The next set of figures, due before the August board meeting, will clarify whether the May jump was noise or the start of a stall.
The board has noted that the longer inflation sits above target, the greater the risk that expectations shift and price-setting behaviour changes. Three rate rises in 2026 have already added roughly 80 dollars a month to repayments on a 500,000 dollar mortgage. The governor’s language this week left the door open to a fourth increase if the data does not cooperate, though market pricing puts the probability of an August move below 30 per cent as of this week.
Supply shocks and their frequency
The governor pointed to an increase in the frequency of supply shocks over recent years: the pandemic, the energy price spike following the invasion of Ukraine, and more recently geopolitical tensions affecting oil markets. Each of these events tightens supply and pushes up prices in ways that monetary policy cannot directly address. The productivity constraint compounds the problem because a less flexible economy absorbs supply shocks less smoothly. When output per worker is growing, firms can meet higher demand by lifting efficiency. When it is not, they raise prices instead.
Oil price movements remain a near-term risk. If prices climb sharply from current levels, headline inflation will lift even if underlying measures stay on their current path. The central bank has noted that fuel price effects have so far been smaller than initially feared, but the governor flagged personal concern about the risk of further increases becoming embedded in inflation expectations. Why the Iran war could wreck Australia’s soft landing walks through the mechanics of how energy shocks translate into domestic price pressure.
Household resilience holds, but caution remains
Consumer sentiment is weak, though it has recovered from its lows earlier in the year. Spending has been more resilient than sentiment surveys alone would predict, and household savings rates appear stable rather than collapsing. That stability matters because it suggests households are not being forced to cut spending sharply in response to higher debt servicing costs. The flip side is that resilient spending keeps demand elevated, which slows the return of inflation to target and delays any rate relief.
The tension is between households who are managing current rates without acute distress and the subset facing genuine pressure. Aggregate data can mask distributional effects. Borrowers who refinanced or took out loans in 2020 and 2021 at rates near one per cent now face serviceability tests at rates above six per cent. RBA Interest Rates Hold, but Borrowers Get No All-Clear examines the range of household positions under current settings.
The call-out: in plain English
Productivity is output per hour worked. When it grows, the economy can expand without generating inflation because workers produce more for each dollar of wages paid. When it stalls, any lift in demand hits capacity limits faster, pushing up wages and prices. The RBA is saying: even if inflation moderates, we cannot cut rates quickly if productivity stays weak, because doing so would risk reigniting price pressure. For mortgage holders, that means the path to lower rates depends on something most people do not track: how much workers produce per hour.
What could derail the base case
The base case assumes inflation continues to moderate gradually, productivity remains weak, and the labour market eases enough to keep wage growth in check without a sharp jump in unemployment. Three things could derail it. First, a fresh supply shock, most likely from energy markets, that lifts headline inflation and shifts expectations. Second, productivity growth turns negative rather than flat, which would force the RBA to tighten further even if inflation is falling. Third, household resilience breaks and spending contracts sharply, which would bring inflation down faster but at the cost of a deeper slowdown and higher unemployment.
The probability of each scenario is unknowable. The central bank is managing trade-offs between the risk of cutting too soon, which would let inflation re-accelerate, and cutting too late, which would impose unnecessary pain on borrowers and weaken growth more than required. Weak productivity tilts the risk management calculus toward caution.
Practical take for decision-makers
If you are carrying variable rate debt, budget for rates to stay at current levels through the second half of this year and into early next year. The first cut, when it comes, is more likely to be shallow than aggressive. Fixed rate offers remain above variable rates at most lenders, which reflects the market’s view that cuts will be slow. If you are considering new borrowing, stress-test repayments at current rates plus one percentage point, and do not assume relief arrives on a set schedule.
For investors, the productivity constraint affects yield expectations. Rents have been rising faster than wages in most cities, but if wage growth stays subdued because productivity is weak, tenant capacity to absorb further rent increases will be limited. Vacancy rates remain low, which supports current yields, but the combination of high rates and weak income growth narrows the pool of tenants who can afford upgrades or relocations. Watch job advertisements and underemployment figures over the next three months as leading indicators of labour market direction.
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General info, not financial advice.
