By Stella Qiu

SYDNEY (Reuters) -Australian consumer price inflation slowed more than expected in May, while the closely watched core measure hit three-and-a-half-year lows as investors locked in bets for an imminent rate cut.

Swaps now imply a 92% probability that the Reserve Bank of Australia would cut rates by a quarter-point when it delivers its policy decision on July 8, a day before the expiry of a 90-pause in U.S. reciprocal tariffs on other countries. That was up from 81% before the data.

Commonwealth Bank of Australia, Deutsche Bank and TD Securities changed their next rate cut call to July from August, while UBS said its expectation for the RBA to hold steady next month is under review.

"Today’s monthly CPI print capped off a flow of data that should provide comfort to the RBA that a swifter return of the cash rate to neutral is both manageable and needed," said Belinda Allen, a senior economist at CBA.

"Maintaining the current restrictive settings for too long raises the risk of inflation undershooting the midpoint."

Data from the Australian Bureau of Statistics on Wednesday showed the monthly consumer price index (CPI) rose 2.1% in May compared with a year earlier. That was down from 2.4% in April and under median forecasts of 2.3%.

In the month, CPI fell 0.4% from April as petrol prices eased and housing costs cooled.

Crucially, the trimmed mean measure of core inflation increased at a slower annual pace of 2.4% in May, coming under the mid-point of the 2-3% target band. That was down from 2.8% in April and also the lowest reading since late 2021.

"We are convinced that the RBA needs to cut in July to safeguard growth as inflation is clearly out of their way now," said Krishna Bhimavarapu, APAC economist at State Street Global Advisors.

"We are tracking faint consumption and growth in Q2, and hence, the bank may do well to frontload the cut to July."

The RBA has cut interest rates twice since February to 3.85% as cooling inflation at home offered scope to counter rising global trade risks. However, the economy barely grew in the first quarter as consumers stayed stubbornly frugal on heightened worries about the economic impact of U.S. tariffs and geopolitical conflicts.

All of that argued for more policy easing from the RBA in the months ahead, with investors expecting a total easing of 78 basis points by the end of the year.

The labour market has so far stayed resilient. The unemployment rate remains low at 4.1% and job advertisements are stabilising above pre-COVID levels. Wages have been well-behaved, with growth in the private sector mostly subdued.