The Reserve Bank of Australia (RBA) raised its Official Cash Rate (OCR) by 25 basis points to 4.35% from 4.10% after its May monetary policy meeting, a move that was widely anticipated by markets and passed by a majority vote of eight to one among RBA members [1][2]. The RBA's Monetary Policy Statement highlighted a significant increase in uncertainty over the domestic economic outlook and inflation, noting that inflation rose materially in the second half of 2025 due to capacity pressures, higher fuel and commodity prices, and the ongoing Middle East conflict [1][2]. Firms have been passing on increased costs through price hikes, and short-term inflation expectations have moved higher [2].
Despite the rate hike, the Australian Dollar remained subdued. The AUD/JPY pair trimmed losses near 112.65 during early European trading hours, while the AUD/USD pair continued to hold losses for the second consecutive day, hovering around 0.7160 during Asian hours on Tuesday [1][2]. The subdued performance of the Australian Dollar was attributed to broader market dynamics, including the strengthening of the US Dollar on safe-haven demand following Iran's attack on the United Arab Emirates (UAE), as well as rising US Treasury yields and expectations that the Federal Reserve may need to lift interest rates further to curb inflation [2].
Geopolitical tensions have had a notable impact on market sentiment. CNBC reported that the UAE was targeted by Iranian drones and missiles, and the US destroyed Iranian boats in the Strait of Hormuz. US President Donald Trump issued a warning that Iran would be “blown off the face of the earth” if it targeted US ships protecting commercial vessels [2]. The fallout from the Iran war is expected to reduce economic growth in 2026 by half a percentage point compared to pre-conflict forecasts, with annual growth projected to halve to 1.3% this year [1].
On the Japanese Yen front, markets remain alert following suspected interventions by Japanese authorities to strengthen the Yen. Japanese Finance Minister Satsuki Katayama stated that Japan can take action against speculative foreign-exchange movements, and there were unofficial signals that the Ministry of Finance and the Bank of Japan intervened in the foreign exchange market on Friday [1]. Commerzbank’s Thu Lan Nguyen commented, “The big question now is: How long will the JPY’s strength last?” [1].
Forward-looking statements from the sources include expectations of continued inflation risks due to higher energy prices linked to the Iran conflict, and the possibility of additional US Federal Reserve rate hikes as noted by Minneapolis Fed President Neel Kashkari [2]. Traders are also awaiting further guidance from RBA Governor Michele Bullock’s press conference [1].
CONCLUSION
The RBA's widely expected rate hike to 4.35% was overshadowed by persistent inflation pressures and heightened geopolitical risks, resulting in a subdued Australian Dollar despite the policy move. Market sentiment remains cautious, with attention focused on ongoing Middle East tensions, potential further US rate hikes, and possible interventions in the Japanese Yen. Investors are looking to upcoming central bank communications for additional direction.