EY Australian Financial Conditions Index: March 2025

Understanding financial conditions beyond just interest rates

Financial conditions are an important contributor to economic growth – an indicator of the stage of the business cycle and what’s ahead.

Tight financial conditions mean it is difficult for businesses to access funding and liquidity is hard to come by, while expansionary conditions mean it is easy for businesses to access capital for growth.

Expansionary conditions (a negative index value) indicate that the financial system is currently supporting the economy. If conditions are restrictive (a positive index value), the financial system is constraining the economy, indicating financial downside risks are present.

The first and most important data point in guiding financial conditions is the cash rate, which the Reserve Bank of Australia sets to steer the economy. However, there are many more variables that are also important.

We draw on a broad number of variables including asset prices, interest rate spreads, credit and money growth, debt securities outstanding, financial market risk and surveyed measures of consumers’ views on their household finances. We focus mainly on Australian variables but also include variables from the United States to capture the strong influence this economy has on Australia and the global economy.

Financial conditions remained expansionary

Financial conditions eased marginally in the March quarter of 2025 compared to the December quarter of 2024, remaining in expansionary territory for the second consecutive quarter. This was mainly driven by the Reserve Bank lowering the cash rate in February.

Underlying inflation has continued to trend down, with the February monthly CPI release indicating that inflation has now been within the Reserve Bank’s target band for three consecutive months. This has increased the Reserve Bank’s confidence that inflation pressures are easing, although it continued to be somewhat concerned about the sustainability of deflation.

Australian bond yields increased slightly in the March quarter, reflecting the rise in United States bond yields, partially offset by the re-pricing of Reserve Bank cash rate expectations. Financial market pricing for United States interest rates shifted higher as the US administration’s policies were assessed to be more inflationary than previously expected.

Consumers’ perception of their household finances over the last 12 months decreased slightly in the March quarter, in a sign that the positive effect of tax cuts on disposable income has been partly offset by continuing cost-of-living pressures. However, the outlook for household finances over the next 12 months improved as the Reserve Bank lowered the cash rate in February, with consumers expecting more rate cuts in coming months.

Total credit growth increased over the quarter as business lending grew strongly, while mortgage debt continued to slow which is being reflected in weak house price growth.

Commodity prices fell slightly in the March quarter, in United States dollar terms, due to a decrease in coal prices. This was driven by increasing supply from the world’s largest producers as a warmer winter in China reduced demand for thermal coal. However, in Australian dollar terms commodity prices increased in the March quarter due to the depreciation of the Australian dollar.

Since the March quarter, financial conditions have been overshadowed by developments in trade policy, triggered by the US Administration’s announcement of broad tariffs on its goods imports. These tariffs and frequent policy changes have led to significant uncertainty and market volatility, due to fears of a slowdown in global economic growth.

Markets are pricing a higher probability that interest rates will be eased in May with further reductions to follow. Approximately 120 basis points of cuts are expected over the remainder of the year, which would take the cash rate to 2.9 per cent by December 2025. This implies the cash rate will fall below the neutral rate, which is estimated by the Reserve Bank to be around 3.5 per cent.¹

While the Reserve Bank continues to be alert to inflation risks domestically, it will need to assess the impacts of US tariffs on Australia and its largest trading partner – China. The Reserve Bank has signalled it will take a forward-looking approach to setting monetary policy and is likely to act in advance of the full impacts being reflected in the data.