Market Musings: RBA: once more, with feeling
The RBA has acted on its ‘hawkish’ comments and announced another 25bp interest rate hike at today’s meeting. After delivering a rapid-fire recalibration in rates earlier in the year and then being on hold since May, the nervousness of RBA officials about inflation, coupled with domestic data related to prices, and another wave of upward pressure from global forces meant today’s move was anticipated. Although the ‘unanimous’ Board vote was a bit of a surprise.
According to the RBA “inflation remains elevated”, some of the “upside risks flagged in August are materializing”, and policymakers remain focused on “ensuring that high inflation does not become embedded”. Today’s step, the 4th so far in 2026, lifts rates to 4.6% (chart 1). This is above the peak reached in the post-COVID inflation fight in late-2023 and is the highest interest rates in Australia have been since 2011.
However, given the larger stock of household debt compared to ~15 years ago, interest rate changes now pack more of a punch than they did back then and the RBA’s policy settings are arguably more ‘restrictive’ (chart 2). Yet they could become even more so as the RBA focuses less on the ‘full employment’ side of its mandate and COVID-era desire to keep the economy on “a narrow path”, and lasers in on slaying the inflation dragon. The RBA reiterated it will “do what it considers necessary” to get inflation back to target including raising the cash rate “further if needed”.
In our opinion, given the still elevated level of demand across the Australian economy, particularly government spending, mixed with supply constraints, lackluster domestic productivity, and global inflation pulse stemming from the protracted US/Iran conflict and AI CAPEX boom, we believe it is more likely than not another 25bp RBA rate rise is delivered. Will this be enough? Possibly not, hence we think that without a noticeable quick/sharp slowdown in growth, downside inflation surprises, and/or further deterioration in the jobs market there is a decent chance the RBA needs to hit the brakes even harder via another rate hike in H1 2027. Markets seemingly agree with ~35bps of further tightening (and a cash rate near ~5%) baked into the interest rate curve by May.
It can be a hard pill to swallow, but a prolonged period of sub-trend/weaker growth is typically the price that needs to be paid to create the extra capacity across the economy required to lower inflation. Indeed, this was acknowledged by the RBA who outlined that “growth in aggregate demand needs to remain subdued for a period” to “reduce capacity pressures” and bring inflation down to where it needs to be (chart 3).
It is a challenging time for households/businesses across interest rate sensitive sectors. Based on the prospect of even higher interest rates, which are a blunt tool that disproportionately affect working age families who hold the bulk of outstanding mortgage debt but are also the engine room of household spending (~51% of GDP, the largest part of the economy), the road ahead seems set to become even more difficult (chart 4). Especially when combined with other cost of living pressures buffeting the private sector, such as elevated fuel costs, and jump in prices over the past few years that have outpaced wages, as well as the pullback in house prices and reduced housing turnover that is also partially related to government tax changes. In time, the slower pace of economic growth should see the unemployment rate (now ~4.6%, its highest since Q4 2021) edge up further (chart 5). This can create negative feedback loops across the Australian economy as softer labour market conditions dampen already below average consumer/business sentiment, and activity is in turn held back by reduced confidence in the outlook which then can flow back into jobs. That said, it is also a tricky time for policymakers as it must be remembered that downside growth risks and the chances of a recession lift with each rate hike beyond ‘neutral’. This is the region we are now in.
For the AUD (now ~$0.6990, a ~2-month low), as mentioned previously, the positive impulse from the string of RBA rate rises that underpinned the appreciation earlier in the year is behind us. FX is a relative price, and other central banks are now also on the move, unlike back then when the RBA was the only game in town. As stressed before, a higher RBA cash rate should translate to a higher average level in the AUD compared a few years ago (i.e. AUD averaged ~$0.6525 over 2024/25), but it does not automatically equate to more AUD upside given what is already discounted into the interest rate curve and the unfolding step down in growth from the combination of factors stated above (chart 6). We think the more worrisome domestic economic environment, shaky global risk sentiment created by the surge in global bond yields and inflation jitters, and firmer USD can exert more downward pressure on the AUD in the near-term. In our view, the shifting landscape may also see the AUD give up ground against currencies such as the EUR, NZD, JPY, GBP, and CNH.
Peter Dragicevich
Currency Strategist - APAC
About the author
