Morgans Advisers: Investment Strategy

In a near-unanimous 8-1 decision, the RBA Board lifted the cash rate by 25 basis points at its 5 May 2026 meeting, taking it to 4.35%. The Board acknowledged that the inflation impulse from the Middle East conflict is now flowing into broader goods and services prices, with early signs that firms facing cost pressures are looking to lift prices. This is the third consecutive hike of 2026, following moves in February and March, and takes the cash rate 75bps above the August 2025 trough of 3.60%. The vote shift from 5-4 in March to 8-1 today is an important signal in the statement. The doves who pushed back in March have moved across, and the Board is now broadly aligned in believing that further tightening was justified.

RBA decision: the next move stays open

The most consequential change from March is in the diagnosis of how the Iran shock is moving through the economy. In March, the language was conditional: higher fuel prices "if sustained, will add to inflation" In May, the Board states that fuel prices "are already adding to inflation" and there are "early signs that many firms experiencing cost pressures are looking to increase prices of their goods and services". That's the second-round effects that economists worry about, no longer a risk but visible in the data.

The vote also tells the story. March was a close 5-4 vote with doves arguing the energy shock could prove transitory. May is 8-1, with the doves having largely accepted that the case for inaction is no longer defensible.

What the Board has not done is telegraph the next move. The phrase "having raised the cash rate three times, monetary policy is well placed to respond" suggests the Board views the cumulative work as substantial. The risk assessment has also softened slightly, with risks now described as "remaining tilted to the upside" rather than the March comments of "tilted further to the upside." Both signals point toward a Board that wants to assess the data through to August before committing to more.

Market consensus has one more 25bp hike in the second half of 2026, taking the cash rate to 4.60%. The risk to that view is asymmetric. If second-round effects intensify or the Middle East situation escalates, multiple additional hikes become possible. If the conflict resolves and energy prices retrace, the Board may pause from here.

Inflation dynamics: Michael Knox's view

Our Chief Economist, Michael Knox sees the headline inflation print of 4.6% as misleading on its own. The petrol price spike from the Middle East conflict adds around 0.8 percentage points to headline inflation, but the RBA looks through one-month events like this. The trimmed mean, which strips out volatile items and is what the RBA actually targets, held steady at 3.3%. That's the number that matters, and it remains stubbornly above the 2.5% target.

The more important story is the divergence Michael sees underneath the headline. Australian inflation now splits cleanly into two pictures. Tradable goods inflation, the part of the economy most exposed to global competition and household discretionary spending, is running at just 1.3% year-on-year, well below target. The parts of the economy most affected by interest rate increases are already responding.

The pressure is coming from non-tradable goods, where inflation is running at 5%. The single largest driver is electricity, which is rising at year-on-year rates between 25% and 37% as government subsidies that suppressed prices through 2024 and early 2025 have unwound. Other administered prices and services costs are also adding to the pressure. This is the part of inflation that monetary policy struggles to influence directly, which is why the RBA is being pushed to keep tightening even though much of the private-sector economy has already cooled.

Michael's updated cash rate model, which uses core CPI, unemployment and bond market measures of inflation expectations, points to an equilibrium cash rate of 4.95%. That's 60bp above today's level. His view is that further hikes are likely if the data does not improve quickly. For investors, this means we should not assume today's move is the last, even if the Board's tone suggests it might pause at the June meeting.​

Portfolio actions for the higher-for-long regime

Today's hike and our view that more is to come reinforce a set of portfolio positions we've been building over the past few months.

·         Reduce duration risk. We've rotated 2.5% across our portfolios from core bond strategies into short-duration or floating-rate income strategies. Sub-debt offers carry without the duration drag while the RBA continues to tighten.

·         Build some defence. We added a small position in Gold at the end of April. Central banks diversifying away from US Treasuries, ongoing US fiscal sustainability, and the stagflation-hedge characteristics support the position.

·         Infrastructure. Inflation-linked cash flows, strategic importance of critical infrastructure and the AI capex tailwind make this a diversifier.

·         Review hedge ratios on global assets. With the rate differential set to widen further, AUD strength is likely to persist, and unhedged offshore exposure remains a translation drag.

·         Underweight major banks. Curve flattening and credit quality risks outweigh the NIM benefit, and a longer-than-market-pricing tightening cycle extends the credit risk window.

See our key higher-for-long equities. Ideas include Sigma Healthcare, Newmont, Amcor, Orica. Collins Foods. See our Best Ideas for more.

Outlook for the cash rate and the AUD

With the Board signalling patience but the underlying inflation case still unresolved, we now expect:

·         The Board to hold at 4.35% in June while assessing the second-round effects, building in the data

·         A further 25bp hike 2H, taking the cash rate to 4.60%

·         The risk skewed toward more tightening if Knox's model proves correct, with peak around 4.85-4.95%

·         The Fed to remain on hold through 2026 at 3.60%, having already repriced higher from the 3.0-3.2% expected in January

·         The interest rate differential to remain supportive of the AUD, with AUD/USD likely to extend toward 0.74 or higher by end-2026

Currency implications matter for portfolios. The AUD is already at a four-year high around 0.72. For Australian investors, unhedged offshore equity has been a drag this year. The S&P 500 is up 5% in local terms but down 2% in AUD. We've been gradually lifting hedge ratios on the global equity sleeve in response.

Andrew Tang
Investment Strategist

Level 21 Aurora Place, 88 Phillip St Sydney, NSW 2000
Email: Andrew.Tang@morgans.com.au
Direct: 02 9043 7902 | Mobile: 0417 789 733

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