Market Musing: RBA & AUD: Stars Aligning
After the string of positive Australian data prints, including the strong rebound in employment, acceleration in domestic demand growth in Q3, and a continuation of the firmer inflation pressures in early Q4, it wasn’t a surprise to see the RBA hold interest rates steady at 3.6%. Rather, the data pulse meant attention was on the RBA’s updated thinking about macro trends, the policy outlook, and balance of risks. And it was on this front a few notable tweaks were made with the RBA Board appearing more unnerved about the inflation trajectory (chart 1). Indeed, in the words of Governor Bullock while the Board “didn’t explicitly consider the case for a rate rise” it did discuss circumstances where there could be a hike next year. Given how things are playing out we feel the February RBA meeting should be considered “live” for an interest rate rise.
According to the RBA, there is “uncertainty about how much signal to take from the monthly CPI”, nevertheless, the “data do suggest some signs of a more broadly based pick-up in inflation” that “will bear close monitoring”. At the same time “economic activity continues to recover”, which if it were to continue may “add to capacity pressures”, and various indicators suggest “labour market conditions remain a little tight” (chart 2).
On net, the still “cautious” RBA believe the data flow suggests the “risks to inflation have tilted to the upside”, but it will take a little longer to assess its “persistence”. We take this as a signal the upcoming Australian inflation reports (for November on 7 January, and for December/Q4 on 28 January), as well as labour market trends (11 December and 22 January) will be lasered in on by the RBA ahead of its next meeting (3 February) when updated staff projections are also due.
As we have outlined previously, in our judgement, various signs mean Australian inflation might struggle to settle near the middle of the RBA’s 2-3% target band, the medium-term aim of policymakers, under current settings (see Market Musing: AUD: worrisome inflation trends). At a bare minimum we believe this points to the RBA holding interest rates in slightly “restrictive” territory for an extended period to achieve the desired outcome. However, the quickening momentum across the private sector, resilient jobs market, sticky inflation, and/or ongoing productivity challenges mean the probabilities are shifting and that the RBA, which actively chose not to be as aggressive as its peers, could be pushed to back-pedal and raise rates next year (chart 3). Bottom line, the RBA left itself little room to absorb positive growth/inflation surprises without adjusting policy.
This is something RBA Governor Bullock alluded to when noting it “looks like additional rate cuts aren’t needed” and the question is if an “extended pause or rate hikes” are required? Markets don't stand still for long and have turned “hawkish” recently with a full 25bp rate rise now factored in by June 2026. Over the last four cycles the average gap between last RBA interest rate cut and first hike was ~10mths (range ~5-18 months). That average puts things around mid-2026 as a potential hiking zone based on the last cut delivered in August 2025. That said, a move as soon as February can’t be ruled out given some past rapid U-turns and domestic economic impulses (chart 4).
More event driven AUD volatility (now ~$0.6643) is possible over the next few days with the US Fed meeting (Thursday morning AEDT) and Australian jobs data (Thursday AEDT) on the radar. We think the USD could recover some lost ground later this week if the US Fed cuts interest rates but sounds more ‘cautious’ about the need to deliver another reduction in early-2026. This may see a bit of heat come out of the AUD in the short-term after its strong run. But we don’t see AUD pull-backs being too deep or lasting too long. Over the medium-term, as per our long held forecasts, we see the AUD grinding up into the high-$0.60s by mid-2026 on the back of an underlying improvement in US/China trade relations, more favourable yield spreads between Australia and other nations, a softer USD, and firmer domestic/Asian growth. Notably, based on current market pricing the RBA-US Fed policy rate spread is projected to swing to ~75bps in the RBA's favour by late 2026 (chart 5). Looking back, the last few times this spread was in this region (i.e. Q1 2017 and Q4 2006) the AUD was hovering in the low to mid $0.70s (chart 6).
Peter Dragicevich
Currency Strategist - APAC
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