Rate rises no longer a distant scenario after inflation news
Australia may be edging closer to another round of interest rate hikes next year, according to Commonwealth Bank chief economist Luke Yeaman, who says the economy is now running uncomfortably close to its “speed limit”, leaving the Reserve Bank little room to loosen policy.
Yeaman’s latest assessment has landed at a time when hopes of rate cuts in 2026 have already been fading.
Stronger-than-expected growth, a resilient employment market and a sharp lift in housing prices have created a backdrop that is far less forgiving for the RBA than it appeared only months ago.
September quarter inflation – particularly a 1% rise in the trimmed mean – has added to concerns that price pressures are proving stubborn.
Diverging paths
Deputy Governor Andrew Hauser recently outlined two contrasting paths for the economy: one where monetary policy remains restrictive enough to bring inflation down, and another where improving demand begins to run ahead of supply, stoking wage pressures and forcing the Bank to act.
Yeaman leans toward the latter risk, warning that if the economy “builds more steam than expected”, rate hikes in 2026 would “come onto the table”.
Fresh CPI data for October has strengthened that possibility. Annual inflation reached 3.8%, exceeding market expectations, while the trimmed mean rose to 3.3%.
Housing is again the key driver, climbing 5.9% over the year, with rents and electricity doing much of the heavy lifting. Food and non-alcoholic beverages, along with recreation and culture, each rose 3.2%, reinforcing the view that price pressures are broadening.
For brokers, the message is becoming clearer: borrowers should not expect relief in the near term. NAB has told customers to prepare for a soft landing, while ANZ has flagged a more hawkish RBA. Major banks are now broadly aligned that any easing cycle in 2026 will be shallow – if it happens at all.
Capacity concerns mount
Underlying many of these developments is the issue of capacity. Productivity growth has slowed in recent years, meaning Australia’s potential growth rate – estimated at about 2.1% – is lower than in past cycles.
With the economy already expanding at a pace close to that level, the risk is that any further strengthening will trigger additional inflation.
The construction sector remains a choke point.
Building approvals have picked up, but capacity constraints persist, feeding into rising dwelling costs. Rising house prices are adding further fuel, and given housing’s outsized influence on the CPI basket, this trend poses a persistent challenge for the RBA.
Service-sector inflation has also lifted, partly driven by businesses restoring margins after a period of soft consumer spending. Whether that fades as conditions normalise will be critical to the RBA’s read on inflation durability in early 2026.
Rates: Steady as she goes, or up again?
While Yeaman does not believe the economy has breached its capacity limits yet, he argues that it is moving closer – leaving the RBA with “little headroom” and forcing policymakers to stay on alert.
Yeaman’s base case assumes rates remain steady through 2026, but he emphasises that any unexpected acceleration in activity, or a tightening in the labour market, could shift the conversation sharply toward rate increases.
The RBA’s February meeting looms as a potential flashpoint. If December-quarter inflation lands above the Bank’s implicit expectations and unemployment edges lower, market pricing for rate hikes is likely to intensify.
For mortgage brokers, the takeaway is that the period of relative stability may not last. With inflation still well above target and momentum in housing showing no sign of easing, the chance of the RBA moving rates higher next year is no longer a distant scenario – it is increasingly part of the central forecast.
‘More likely to be a hike’
Now, Barrenjoey and UBS have shifted their forecasts to predict the RBA will need to lift the cash rate rather than cut it.
Barrenjoey’s chief economist Jo Masters expects the cash rate to rise to 3.85% in May, with another increase likely in August.
The bank had previously assumed one final cut in 2026, but Wednesday’s inflation print has upended that view.
Barrenjoey chief rate strategist Andrew Lilley was reported by The Australian Financial Review as saying that “the next RBA move is more likely to be a hike than a cut”, warning that goods inflation had now reaccelerated alongside still-hot services prices.
Bond markets reacted immediately, slicing the odds of a rate cut by June to just 23 per cent, while traders began pricing in a small chance of a tightening by year-end.
UBS also shifted its stance, with chief economist George Tharenou telling the AFR that the data shows “more of a ‘trend’ of higher inflation”. The Australian dollar strengthened and bond yields rose as investors absorbed the likelihood that the RBA will stay on high alert.
