Statement on Monetary Policy – August 20251. Financial Conditions

1.1 Interest rate markets

Market participants expect policy rates in most large economies to decline further over the rest of this year.

Market pricing implies most advanced economy central banks are expected to ease policy by more than had been expected before the April tariff announcements (Graph 1.1). This is consistent with the view that tariffs are likely to have a modest disinflationary impact in most advanced economies due to an adverse impact of tariffs on global demand. Market expectations for the path of policy rates increased in the United States and Canada after the April announcements, where the impact of tariffs is likely to be inflationary. Nevertheless, market participants expect US monetary policy to become less restrictive alongside a moderation in economic activity and a softening in the labour market, the effects of which will tend to outweigh the inflationary impact of tariffs over the medium term. This expectation was supported by labour market data in August, which caused the expected US policy rate path to decline. In Canada, the higher market path for policy rates since April was supported by stronger-than-expected June labour market data. The market path in Japan increased after the announcement of a trade deal with the United States, which alleviated a significant downside risk to economic activity in Japan.

Since the May Statement, most central banks have adjusted policy rates in line with market participants’ expectations. The US Federal Reserve (Fed) kept its policy rate on hold in June and July. At the July meeting, Chair Powell noted that trade policies had started to increase goods inflation and that it is uncertain whether the effects on overall inflation would be short lived or more persistent. However, two members of the Federal Open Market Committee voted to lower the policy rate by 25 basis points.

US policy rate expectations of further cuts in the second half of 2026 have also been influenced by speculation that Chair Powell will be replaced at the end of his term as chair in May 2026 by a candidate that favours a lower policy rate path.

The Bank of Canada and the Bank of England also left their policy rates unchanged, highlighting upside risks to inflation and downside risks to the labour market, respectively. By contrast, the European Central Bank (ECB) and Reserve Bank of New Zealand lowered their policy rates, as expected. Both highlighted continued progress on disinflation and downside risks to domestic and global growth associated with US trade policy as factors in their decision to lower rates.

Since May, the Bank of Japan (BoJ) has kept its policy rate unchanged and decided to slow the pace of quantitative tightening from April 2026. This means that the BoJ’s bond portfolio will decline more slowly than previously planned. The decision was expected by markets and is designed to support stability in the Japanese Government bond market. This follows a significant rise in long-term yields in May, owing to factors including a decline in investor demand.

The People’s Bank of China has maintained a moderately accommodative policy stance since May. It has noted that further monetary policy easing is constrained by bank profit margins, which are currently narrow and would be squeezed more if policy were eased further. The recent meeting of China’s Politburo emphasised continuity of monetary and fiscal policy, with a focus on the implementation of already-announced policy to achieve the 5 per cent growth target.

A number of central banks have signalled that they are waiting to learn more about the impact of tariffs before adjusting policy if necessary. In the United States, Chair Powell has noted that, with inflation slightly above target and the economy at full employment, the current modestly restrictive stance of monetary policy leaves the Fed well-placed to respond as the impact of tariffs on inflation becomes clearer. The ECB Governing Council has noted that the environment remains exceptionally uncertain, especially because of trade disputes, and will adopt a data-dependent and meeting-by-meeting approach to determining the appropriate monetary policy stance.

In Australia, market participants’ expected path for the cash rate has declined since the May Statement.

The near-term path for the cash rate implied by market pricing suggests the cash rate is expected to gradually decline to around 3.1 per cent by early 2026. The market path declined following RBA communications on the policy decision in May, although it partially retraced that after the cash rate was left unchanged in July whereas the market fully expected a 25-basis point cut. Domestic economic data that overall were a little weaker than expected by market participants also contributed to the decline in the market path since the May Statement. A 25-basis point reduction in the cash rate at the August meeting is fully priced in by markets and an additional two further cuts are expected by early next year (Graph 1.2). Most market economists’ expectations for the cash rate are broadly consistent with the market path.

The forecasts provide the RBA’s most comprehensive assessment of the economic outlook for a given cash rate path. In this Statement’s baseline forecast, which is conditioned on the current market path for the cash rate, activity and the labour market are projected to move into balance, keeping inflation sustainably around the midpoint of the target range (see Chapter 3: Outlook). This is consistent with earlier restrictive monetary policy having worked to slow the growth of demand and with policy having become somewhat less restrictive since February. This easing of restrictiveness is evidenced in a number of measures of financial conditions, with household credit growth, for example, having increased to around the current pace of disposable income growth. This followed a sustained period of decline in the ratio of household credit to disposable income in response to the earlier rise in interest rates. This picture is also consistent with the fact that the cash rate had been above the range of model-based estimates of the neutral interest rate, but the current cash rate path now falls within that range. These models provide a complementary measure of the restrictiveness of policy, although they are subject to substantial uncertainty – around both the models and the estimates of the parameters within each model.

Ten-year government bond yields in most advanced economies are within the range they have been trading in since 2023, while 30-year yields have been trending higher.

Ten-year US Treasury yields have declined since the May Statement and by more than yields on other advanced economies’ bonds (Graph 1.3). This decline was underpinned by a reduction in real yields alongside indicators suggesting a softening labour market amid higher trade barriers. Longer term inflation compensation has remained stable but shorter term inflation compensation has increased, based on measures derived from swaps (Graph 1.4). This is consistent with evidence that tariffs have to date had a modest inflationary impact in the United States and an expectation that inflation will be somewhat higher over the next year. Government bond yields in Australia have declined since the May Statement, also driven by a decline in real yields, with longer term inflation compensation remaining stable. By contrast, yields in Japan have increased somewhat alongside higher policy rate expectations and uncertainty about fiscal policy after the Japanese election in July.

Ten-year yields remain below their late-2023 peaks in most advanced economies, though term premia have risen alongside higher expected growth of public debt in a few large economies and further declines in the size of central bank balance sheets. Thirty-year government bond yields have risen more noticeably since the start of the year in many advanced economies. Nevertheless, term premia remain modest by historical standards, suggesting investors do not have material concerns about fiscal sustainability.

1.2 Corporate funding markets

A range of other measures of financial conditions have eased in Australia and other economies since the May Statement.

In most advanced economies, equity prices have increased to near historical highs and equity risk premia have declined a little and are close to the historically low levels reached earlier in the year. Large technology companies have driven most of the increase in the S&P 500 since the May Statement, which reflects better than expected earnings and investor expectations about future returns rather than a broad-based improvement in the economic outlook . In Australia, equity prices remain elevated, after reaching a new peak in early August, with analysts’ earnings forecasts for the ASX 200 little changed, and the equity risk premium around its lowest level since 2009 (Graph 1.5). The expected volatility of equity prices across most advanced economies, including Australia, remains below long-term averages.

In China, equity prices are near their year-to-date highs, though well below previous peaks, driven by improved risk sentiment as trade negotiations with the United States progressed (Graph 1.6). The shift of local investors towards higher yielding assets has corresponded with a slight increase in Chinese Government bond yields from recent lows. Total credit demand remains weak, against the backdrop of historically low private sector credit growth in China.

Corporate bond yields have declined in the United States, Europe and Australia, reflecting both the decline in government bond yields and a narrowing in spreads (Graph 1.7). Spreads on higher rated debt across advanced economies, and lower rated European debt, are back near the lows seen before the April episode of volatility.

Low risk premia suggest that market participants are not placing much weight on the potential for materially adverse outcomes for economic activity or inflation from evolving trade policies and geopolitical uncertainty, or that they are expecting such risks to be offset by fiscal stimulus or monetary policy. This is evidenced, for example, by the cost of hedging against negative tail risks to US equity prices being close to its long-term average despite the highly uncertain environment. Consequently, there is a risk that unexpected adverse outcomes could tighten financial conditions globally and in Australia – for example, by driving a significant decline in equity prices and/or a widening in corporate bond spreads.

1.3 Foreign exchange markets

The Australian dollar trade-weighted index (TWI) remains around the bottom of the range observed over recent years.

The Australian dollar is little changed on a TWI basis and has appreciated slightly against the US dollar since the May Statement (Graph 1.8). The stability of the Australian dollar over this period is consistent with both overall commodity prices and the spread between Australian and other advanced economy bond yields having been little changed on average. Since the start of the year, however, the Australian dollar has appreciated noticeably against the US dollar, reflecting broad-based US dollar weakness (discussed below). The Australian dollar TWI has reacted broadly as expected to the reductions in the cash rate since the start of the year.

The US dollar TWI has depreciated a little further since the May Statement.

The depreciation of the US dollar TWI since May has been driven by a decline in US Government bond yields following data suggesting the US labour market is softening. The US dollar TWI is around 7 per cent lower than at the start of the year but remains around the average level seen over prior years (Graph 1.9). The depreciation since the start of the year has reflected concerns about US trade policies and their effects on the US economy. These factors have also supported the euro, which has appreciated markedly since the beginning of the year.

Some international investors have increased their currency hedges on US-dollar assets since the market volatility in April, which, at the margin, contributed to the US dollar weakness seen since the start of the year. Borrowing US dollars using FX and cross-currency swaps is one way that investors can hedge their US-dollar assets. However, FX swap basis – which represent the difference between the cost of borrowing non-US currencies using FX swaps and borrowing them in onshore markets – have remained stable in most major currencies, whereas it tends to fall if demand to borrow US dollars is high (Graph 1.10). This suggests that hedging-related changes in demand are likely to have been small.

The Chinese renminbi has depreciated on a trade weighted basis since the May Statement, and is well below its historical peak in 2022. However, it has appreciated by around ½ per cent against the US dollar. This partly reflects progress in US–China trade negotiations and Chinese authorities not leaning against the appreciation. Chinese authorities have also proposed incremental actions to increase financial openness. This has included an expansion of the quota for qualified local institutional investors to invest in overseas assets and a proposal to remove restrictions for foreign access to futures trading in local commodities markets. These developments, together with recent communication by policymakers, have pointed to an increased emphasis on longer term ambitions for greater use of the renminbi internationally.

1.4 Australian banks and credit markets

Bank funding costs have declined after the cash rate reduction in May and on expectations of further cash rate cuts.

The RBA’s estimate of major bank funding costs has declined to around 70 basis points below its recent peak in 2024 (Graph 1.11). That partly reflects a fall in banks’ deposit rates following the May cash rate reduction. It also reflects a decline in bank bill swap rates (BBSW) – to which much of banks’ funding costs are linked – due to the actual and expected cash rate reductions. Spreads between bank bond yields and swap rates have also narrowed to around their lowest levels since 2022 as risk sentiment has improved, contributing slightly to lower wholesale funding costs for banks. The pace of bank bond issuance has been around its decade average after a brief pause in April.

Lenders have passed on the May cash rate reduction to lending and deposit rates.

Average new and outstanding variable mortgage rates declined by around 25 basis points over May and June (Graph 1.12). The average interest rate on new fixed-rate mortgages also decreased and is around 30 basis points lower than it was at the end of last year. Business lending rates have declined alongside declines in BBSW and the cash rate. Since the May Statement, banks have lowered rates on at-call and new term deposits by around 20 basis points up to June.

Scheduled mortgage payments decreased further in the June quarter (Graph 1.13). Total scheduled mortgage and consumer credit payments, as a per cent of household disposable income, have declined by around 30 basis points since their late-2024 peak. The flow of extra mortgage payments into offset accounts and redraw facilities has decreased but is still a little above its pre-pandemic average.

The stock of total credit has increased relative to GDP since late 2023, though it remains below its pre-pandemic level.

Total credit growth has been stable in 2025 (Graph 1.14). Credit demand has been robust, particularly from businesses, and credit supply has been supported by strong competition for housing and business lending. Liaison information suggests that lending standards have not changed materially for housing and business lending over recent quarters, though some banks have eased terms for commercial property lending.

Household credit growth increased modestly in the June quarter, to be broadly in line with the expected growth in household incomes.

Housing credit growth has recently increased a little, to around its post-GFC average (Graph 1.15). The increase is consistent with borrowers responding to lower lending rates and expectations of stronger housing price growth, alongside the recent pick-up in actual housing price growth (see Chapter 2: Economic Conditions). In past episodes of policy easing, the response of housing credit growth to lower interest rates has varied materially in both timing and magnitude. The ratio of total household credit (including personal credit) to household disposable income looks to have stabilised in the June quarter, though net household indebtedness (which also accounts for growth in offset balances) is likely to have continued to decline (Graph 1.16).

Growth in business debt has remained strong.

Growth in business debt has increased to around its fastest pace since 2008 in nominal terms, and to around pre-pandemic levels as a share of GDP (Graph 1.17). Growth has remained broadly based across industries. Bond issuance by non-financial corporations this year has been stronger relative to GDP than over most of the prior decade. There has so far been no evidence that overall demand or supply of business credit has softened materially in response to trade policy uncertainty.

Business debt growth has been supported by strong competition among lenders and favourable conditions in wholesale funding markets. Some Australian banks have noted in recent profit reports that they had increased their strategic focus on business lending, partly in response to low profit margins on mortgage lending. Competition from non-bank lenders has also been strong. These trends have likely made it easier and cheaper for some businesses to access credit, supporting their ability to manage cashflows, grow and invest. This suggests that credit supply has not been a material driver of flat private business investment over recent quarters (see Chapter 2: Economic Conditions). Historically there has been a weak relationship between aggregate private business investment and business debt growth.