What’s behind the decision?
The RBA’s concern about upside risks to inflation intensified over the past month, alongside evidence that underlying inflation remains too high. Today it acted on those concerns, lifting the cash rate by a quarter of a per cent to 4.60%, the highest level since 2011. The Board decision was unanimous.
The accompanying statement highlighted a more challenging global backdrop. The RBA noted that the conflict in the Middle East has broadened and global energy prices are now higher than assumed in last month’s forecasts. Average Brent crude prices since the last Board meeting have been nearly 18% higher than the average between the previous two meetings.
Beyond energy prices, the RBA also pointed to strong growth in AI-related investment globally, which is boosting demand for technology-related goods and placing pressure on productivity capacity.
Moreover, its business liaison program suggests firms continue to face cost pressures with many already passing these costs on through higher prices or considering doing so. We recently explored this theme in, The Bookstore, Bullock and the Inflation Problem.
Interestingly, the RBA noted that growth among Australia’s trading partners has been stronger than expected. The lift from AI-related investment has more than offset the economic drag from the Middle East conflict.
A key concern for the RBA is that inflation expectations become unanchored. If households and businesses come to believe inflation will remain high, those expectations can become embedded in pricing decisions, making inflation harder and more costly to bring back to target.
While the RBA cannot prevent external shocks such as higher energy, freight or input costs, it can seek to limit the second-round effects that flow through the broader economy. These occur when an initial increase in costs prompts businesses to lift prices, which then spreads inflation more widely. Industries such as transport, construction, mining and agriculture are particularly exposed to higher fuel and input costs.
The labour market was also firmly in the RBA’s sights. While the unemployment rate has drifted higher, it masks continued strength in employment growth. In fact, the unemployment rate would have fallen last month had more people not entered the workforce looking for work, reflected in the higher participation rate.
A blunt instrument, but inflation hurts everyone
The cash rate is often described as a blunt instrument and for good reason. A rate rise affects the entire economy, but not every household equally. Borrowers with a variable-rate mortgage feel the impact almost immediately through higher repayments. On a mortgage of $250,000 over 25 to 30 years, today’s increase will add around $40 a month to repayments.
Yet inflation imposes a cost on everyone. It shows up at the supermarket checkout, in utility bills and across a wide range of day-to-day expenses. Even retirees who own their homes outright and rely on fixed incomes may find those incomes struggle to keep pace with rising living costs.
So, while higher interest rates undoubtedly hit some households harder than others, allowing inflation to remain elevated ultimately causes broader and more persistent damage across the economy.
So, what’s next?
The key question now is what comes next. Has the RBA reached the end of this tightening cycle, or is there more to come?
Financial markets were fully priced for today’s move. They are also pricing in around 1.9 additional rate hikes over the next 12 months (up from 1.7 rate hikes before the decision). We think this pricing is too aggressive.
The balance of risks remains finely poised. The Middle East conflict, AI-related investment and capacity constraints continue to present upside risks to inflation. At the same time, higher interest rates are weighing on parts of the economy, particularly the housing market, which could dampen economic activity and inflation.
Governor Bullock noted in her press conference that monetary policy is already restrictive. Whether it proves restrictive enough to bring inflation sustainably back to target without further tightening remains to be seen.
A recent Bloomberg survey of 43 economists found that only eight expect a follow-up rate increase in either November 2026 or February 2027. That said, expectations can shift quickly. Much will depend on the economic data released between now and the November meeting, beginning with tomorrow’s August inflation figures.
We had expected the cash rate to peak at 4.60%, but today’s hawkish rhetoric has increased the possibility of a follow-up move in November. Even so, almost two additional rate hikes over the next year still seems a stretch. There remains considerable uncertainty around the outlook.
In a recent fireside discussion, Governor Bullock devoted significant attention to geopolitical risks, supply-chain disruption and their potential implications for inflation. These risks are difficult to forecast, which is why another increase remains a possibility. As the RBA noted today, “there continue to be heightened uncertainties about the outlook for domestic economic activity and inflation”.
For now, the message from the Board is clear – inflation remains the priority and the RBA is prepared to tighten policy further if needed to return inflation sustainably to target.
