RBA's Internal Split Deepens as Terminal Rate Forecasts Climb Toward 4.85%

The Reserve Bank of Australia (RBA) faces its most contentious rate decision in years when Governor Michele Bullock announces the May policy outcome at 2:30 PM AEST on Monday, May 5. While markets assign a 70% probability to a 25 basis point hike lifting the cash rate to 4.35%, the deeper story unfolding is the growing internal fracture within the Monetary Policy Board and a dramatic upward revision of terminal rate forecasts across major banks.

A Divided Central Bank

The March 2026 decision exposed a rare 5-4 split within the RBA's Monetary Policy Board. Five members voted to raise rates to 4.10%, while four preferred to hold steady at 3.85%. Governor Bullock acknowledged the division publicly, noting that while the Board "doesn't want to have a recession," they may be forced to tolerate one if inflation proves more stubborn than expected.

The April decision saw another 25bp hike to 4.35%, bringing the cumulative tightening since February 2026 to 75 basis points. This aggressive pace reflects mounting concern that cpi" title="Understanding inflation and CPI in forex">inflation, which surged to 4.6% in March from 3.7% in February, is becoming entrenched well above the RBA's 2-3% target band.

The split vote signals deep disagreement over the appropriate policy response. Hawks on the Board emphasize upside inflation risks, particularly the risk that inflation expectations could become unanchored if the public loses confidence in the RBA's commitment to price stability. Doves counter that rising unemployment and slowing growth indicators suggest the economy is already weakening under the weight of prior rate hikes.

Energy Shock Compounds Inflation Challenge

The Iran conflict and the effective closure of the Strait of Hormuz have added a significant supply-side shock to Australia's inflation picture. Brent crude prices surged above $118 per barrel in late April, driving fuel costs sharply higher. The CPI data shows energy-related inflation contributing materially to the March spike, though the RBA has been careful to note that domestic demand pressures were already too strong even before the oil shock hit.

Central bank communications in recent weeks have emphasized that core inflation, which strips out volatile food and energy prices, remains elevated at 3.3%. This suggests inflationary pressures are broad-based, not solely driven by geopolitical events beyond the RBA's control.

Terminal Rate Forecasts Surge

What's catching traders off guard is the rapid upward revision of peak rate forecasts. As recently as March, no economists surveyed by Reuters expected the cash rate to exceed 4.35%. That consensus has collapsed.

According to a Reuters poll conducted May 1, more than one-third of economists now expect the cash rate to reach 4.60% or higher in 2026. Several major forecasters have gone even further:

• Westpac: Expects the RBA to deliver two additional hikes beyond May (in June and August), taking the cash rate to a peak of 4.85%
• Capital Economics: Forecasts rates reaching 4.60% by Q3 2026, with the next move coming as soon as May 5
• Commonwealth Bank: Sees at least one more hike after May, pushing the rate to 4.35% minimum, with further tightening possible if inflation doesn't ease
• National Australia Bank: Warns of risks for "earlier and more aggressive" hikes beyond a baseline expectation of 4.60%

The shift in forecasts reflects two key factors: the stickiness of inflation despite prior rate hikes, and the RBA's explicit warnings that it will tolerate economic pain to restore price stability.

Wage Growth Remains Elevated

Labor market tightness continues to fuel wage pressures. The Wage Price Index rose 0.8% in Q4 2025, bringing annual growth to 3.4%. While this is below the RBA's estimated level consistent with its inflation target (around 3.0-3.5% depending on productivity growth), wages are rising faster than productivity, squeezing corporate margins and feeding into consumer prices.

Public sector wage growth accelerated to 4.0% year-over-year in the December quarter, up from 3.9% in September. Private sector wages are following suit, though at a slightly slower pace. Commonwealth Bank's proprietary wage tracker, based on 400,000 salary accounts, shows wages rising 3.1% annually through March 2026, with quarterly growth holding at 0.8%.

The RBA has signaled that it expects wage growth to ease toward 3.0% by mid-2026, but there is little evidence of that deceleration yet. If wages remain elevated, the central bank will face continued pressure to tighten further to prevent a wage-price spiral.

What Traders Should Watch Monday

Monday's 2:30 PM AEST announcement will include both the rate decision and a policy statement from Governor Bullock. Key areas of focus:

• Forward guidance language: Does the statement signal "further tightening may be required," or does it adopt more neutral language suggesting a pause is possible after May?
• Inflation forecast revisions: Will the RBA raise its inflation projections for 2026 and 2027, reflecting the oil shock and stickier core inflation?
• Growth and unemployment trade-offs: Will Bullock acknowledge rising downside risks to growth, or maintain a hawkish tone emphasizing inflation risks?
• Vote split disclosure: If the Board remains divided 5-4 or shifts to a different configuration, this will be disclosed in the statement and could signal the balance of risks going forward

AUD/USD Positioning and Technical Levels

The Australian Dollar has been volatile in recent weeks, caught between hawkish RBA expectations and global risk-off flows driven by the Iran conflict. AUD/USD is currently trading near 0.6450, down from April highs above 0.6600 as the US Dollar strengthened on safe-haven demand.

Key technical levels to watch:

• Resistance: 0.6500 (psychological level), 0.6580 (April high), 0.6650 (major resistance from Q1)
• Support: 0.6400 (round number and recent low), 0.6320 (March low), 0.6200 (critical long-term support)

A hawkish hike with strong forward guidance could push AUD/USD back toward 0.6550-0.6600. Conversely, a dovish hike (a rate increase accompanied by language suggesting a pause ahead) or an unexpected hold could see the pair test 0.6400 and below.

Implied volatility on AUD/USD options has risen ahead of the decision, with one-week implied vol sitting near 12%, well above the 30-day average of 9%. This suggests options markets are pricing significant two-way risk.

Comparing RBA and Fed Trajectories

The divergence between the RBA and the Federal Reserve is becoming stark. While the Fed held rates at 3.50-3.75% at its April meeting and signaled a prolonged pause, the RBA is accelerating tightening despite a smaller economy and greater sensitivity to interest rate changes (due to Australia's high household debt levels).

This policy divergence has significant implications for AUD/USD. If the RBA continues hiking while the Fed remains on hold, interest rate differentials should favor the Australian Dollar. However, if the aggressive tightening tips Australia into recession, risk-off flows could overwhelm rate differential support.

Traders should also monitor the US Nonfarm Payrolls report due Friday, May 9. A strong NFP print could revive Fed hawkish pricing, supporting the US Dollar and weighing on AUD/USD regardless of the RBA's decision.

Broader Market Implications

An RBA hike on Monday would mark the third consecutive increase and the seventh tightening move since the current cycle began. For Australian equity markets, higher rates pose a direct threat to valuation multiples, particularly for rate-sensitive sectors like real estate and utilities. The ASX 200 has underperformed global peers in recent weeks as rate hike expectations have risen.

Australian government bond yields have already priced in much of the expected tightening. The 3-year yield is trading near 4.20%, up from 3.60% in early March. If the RBA signals a higher terminal rate on Monday, expect yields to push toward 4.50% or higher, further inverting the yield curve and raising recession risks.

For forex traders, the key question is whether the RBA's aggressive stance can offset the powerful safe-haven bid for the US Dollar. History suggests that during periods of elevated geopolitical risk, interest rate differentials take a back seat to risk appetite. If the Iran conflict escalates further, even a hawkish RBA may struggle to support the Aussie.

Conclusion: A Pivotal Week for AUD

Monday's RBA decision is shaping up as a defining moment for Australian monetary policy and the Australian Dollar. With inflation well above target, a divided Monetary Policy Board, and terminal rate forecasts climbing toward 5%, traders face a complex risk landscape.

The safe bet is a 25bp hike to 4.35%, but the forward guidance and tone will matter far more than the rate move itself. If Bullock signals that the tightening cycle has further to run—potentially much further—AUD/USD could find support despite global headwinds. But if the statement hints at growing concern over growth risks, the currency may struggle even after a hike.

Traders should position for volatility and be prepared for a larger-than-usual move in AUD/USD and Australian bond markets. With the RBA meeting Monday and US NFP on Friday, it's set to be a consequential week for the Australian Dollar.