The case for RBA patience is getting stronger

Markets may be leaning dovish, but the data no longer is. Labour supply is slowing, inflation is synchronising upward, and supply-side optimism looks premature.

The Bull Case for Rate Cuts

Luci Ellis, Westpac's Chief Economist and former RBA Assistant Governor, has been making a compelling case for further rate cuts. Her argument rests on supply-side optimism: Australia's productive capacity is higher than the RBA assumes.

Her logic is straightforward. Where the RBA assumes trend growth of 2%, Ellis argues for 2.2% or higher. Even accepting conservative productivity estimates (~0.7%), labour supply growth could reach 1.5-1.6% annually rather than the RBA's 1.3% assumption. Immigration skews young, workforce participation is trending up, and business investment is picking up - all supportive of future capacity.

If Ellis is right, the RBA risks "keeping interest rates too high for too long." With more capacity than assumed, the economy can grow faster without triggering inflation. Rate cuts become viable.

It's a coherent argument. The difficulty is that recent data points the other way.

The dovish case rested on three legs: rising labour supply, steady disinflation, and evidence that elevated prices reflected administered costs rather than demand. All three have weakened.

The Supply Side: Hopes vs Data

Ellis's thesis depends on strong labour supply growth and rising participation. But the numbers tell a different story.

Labour force growth has decelerated - from around 3% annual growth in early 2025 to 1.67% now. Monthly growth has turned negative in recent prints. The trend is downward, not upward.

The participation rate has peaked and rolled over. After climbing through 2023 and 2024, participation hit 67.2% in early 2025 and has since declined to 66.7%. The trend has turned.

Ellis's thesis	Recent data
Labour supply growth 1.5-1.6%	Decelerating to 1.67%, trend down
"Upward trend in participation"	Participation peaked, now falling
Business investment supports capacity	Capital growth has halved over the past decade
Productivity around 0.7%	Multi-factor productivity has trended toward zero

Our own modelling, using a Cobb-Douglas production function approach, suggests potential growth is constrained by all three components: capital growth has halved from its earlier levels, labour force growth is slowing, and multi-factor productivity has essentially flatlined. The resulting estimate of potential growth sits around 1.9%, below the RBA's 2% assumption - not above it as the doves would have it.

If participation is falling and labour supply is decelerating, then potential growth is not rising - it's decelerating. That directly undercuts Ellis's central premise.

The Irony of the Jobs Data

There's an irony in how the recent employment data has been received. Doves pointed to signs of labour market softening as evidence that slack is opening up - strengthening the case for rate cuts.

But look at the same data through a supply-side lens and you get the opposite conclusion.

If the "softening" reflects weaker labour supply growth rather than weaker labour demand, then the economy's speed limit is falling. A slower-growing labour force means lower potential growth. Lower potential growth means less room for the economy to run before hitting capacity constraints.

The dovish reading: "Labour market softening → more slack → room to cut."

The supply-side reading: "Labour supply weakening → potential growth falling → capacity more constrained → less room to cut."

Same data. Opposite implications. It all hinges on whether you think you're seeing demand weakness (cyclical slack opening up) or supply constraints (structural speed limit falling).

And with participation now falling and labour supply decelerating, the supply-side interpretation cleanly fits the broader set of indicators. That's not good news for doves. 

Viewed this way, the jobs data and the inflation data aren't sending mixed signals - they're telling the same story. An economy that's supply-constrained, not demand-deficient.

The Inflation Picture is Muddying

Ellis's argument also requires inflation to cooperate - to keep falling, or at least stay contained, as evidence that capacity is higher than feared.

For a while, this looked plausible. Inflation fell steadily through late 2024 into early 2025, with core measures approaching the target band.

But since mid-2025, the picture has shifted. And it's the pattern that matters:

• Goods and services - both rising together
• Tradables and non-tradables - both rising together
• Trimmed mean and weighted median - both ticking up from their troughs

Synchronisation across inflation measures is usually a sign of underlying demand pressure rather than sector-specific distortions. When all the pairs move together, it's harder to dismiss as noise.

Ellis has argued that elevated inflation is largely "policy-driven" - administered prices for utilities, insurance, healthcare, and education that monetary policy can't touch. If that were the whole story, we'd expect divergence: domestically-driven components falling while administered prices stayed elevated.

Instead, we see convergence in an upward direction. Tradables have bounced from near-zero to around 2%. Goods inflation has recovered from 1% to 3%.

And the exchange rate timing doesn't fit. While the TWI did depreciate from around 64.5 in mid-2024 to a low of 57 in April 2025, tradables inflation picked up precisely as the currency was recovering-climbing back toward 62. If this were a pass-through story, we'd expect the inflationary impulse during the depreciation phase, not during the appreciation. The synchronised upturn across measures despite a strengthening currency points to demand, not import prices.

When goods and services, tradables and non-tradables all move up together - and the exchange rate isn't the culprit - it's hard to square with the "it's all administered prices" narrative.

Uncertainty Remains

To be clear: we're talking about one or two quarters of upturn data. That's not enough to pound the table.

The synchronised upturn could still prove temporary - a bump on the road back to target rather than a change in direction. Core inflation remains within striking distance of the 2-3% band. We're not in emergency territory.

But the direction of evidence has shifted. Six months ago, the data was cooperating with the dovish narrative. Now it's pushing back.

RBA Got It Right

Against this backdrop, the RBA's decision to hold rates at its December 2025 meeting was correct. Not because inflation is spiralling - it isn't - but because the balance of risks has tilted: upside risks to inflation now exceed downside risks to activity.

With unemployment running slightly below NAIRU, the output gap near zero, labour supply growth decelerating, and inflation measures turning up together, the risk of cutting too early has increased.

This doesn't mean a rate hike is imminent. The data doesn't scream "emergency."

But it does mean the burden of proof has shifted. The doves need the data to start cooperating again. Right now, it isn't.

The Luxury of Patience

Here's the under-appreciated point: at current levels, waiting for more clarity is low-cost.

The cash rate at 3.60% is neither crushing nor overheating the economy. Growth is modest but positive. Employment is holding up. Households are under pressure but managing.

In this zone, the cost of waiting is low; the cost of a misstep is high.

Neither path - up or down - looks like an immediate necessity. The RBA can afford patience without incurring significant costs either way. That's a luxury worth using.

Conclusion

The dovish case isn't dead. Supply-side surprises can happen. Immigration could reaccelerate. Participation could rebound. Productivity could pick up. Ellis may yet be vindicated.

But right now, the edges are fraying. The labour market dynamics she's counting on are moving against her thesis, not with it. The inflation data is no longer cooperating. The synchronised upturn across goods and services, tradables and non-tradables - with a stable exchange rate - is hard to square with the "it's all administered prices" narrative.

One quarter does not make a cycle. But when the price measures start moving in formation, you pay attention.

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The views expressed here are analytical observations, not policy recommendations.