RBA pulls the trigger
The Reserve Bank’s Board lifted the cash rate to 3.85%, citing stronger-than-expected inflation and growing demand pressures.
The Reserve Bank of Australia’s Monetary Policy Board raised the cash rate by 25 basis points today, bringing it to 3.85%. Stronger-than-expected inflation in the second half of 2025, paired with a labour market that remains resilient are the key drivers of the Reserve Bank’s decision. Taken together, recent data demonstrates that growth in private demand has strengthened substantially, adding to capacity pressures across the economy. This has provided evidence for the Reserve Bank to put an end to their rate cutting cycle – a fact that would have seemed unlikely a few months ago.
Headline inflation reached 3.8% over the year to December 2025, well outside the target range. Critical to the Reserve Bank’s decision was the contribution of domestically driven sources of inflation across a broad range of goods and services. In particular, housing (5.5%), food and non-alcoholic beverages (3.4%) and recreation and culture (4.4%) prices all grew strongly. Robust growth in housing costs in part reflected state government electricity rebates being used up by households in Queensland and Western Australia, driving up electricity costs by 21.5% over the year to December 2025.
The underlying (trimmed mean) measure of inflation – the RBA’s preferred measure – also remains persistently high, growing to 3.3% over the year to December 2025. Trimmed mean inflation has now remained above the RBA’s target band of 2-3% for four consecutive months and is expected to remain above target for some time. The Reserve Bank today highlighted that while part of the pick-up in inflation is due to temporary factors, private demand has grown quickly, and capacity pressures are greater than previously assessed.
Despite high inflation, the decision to raise the cash rate was likely a closer call than the 72% priced by financial markets prior to the decision suggests. While hot inflation data clearly highlights domestically driven price pressures in the Australian economy, there remains a question as to how much of the price growth is transitory versus structural. Monthly inflation data is also noisy and has been impacted by the withdrawal of energy rebates. Additionally, while the unemployment rate did drop to 4.1% in November 2025, it remains to be seen if one strong month represents a new trend. Only 72,700 jobs had been created over the six months prior – that would normally be considered tepid growth for employment. The concern is that raising interest rates is pre-emptive and risks weighing on economic activity.
The Reserve Bank’s Statement on Monetary Policy (SoMP) indicates that underlying inflation is not expected to return to the 2-3% target range until early 2027. The SoMP does not provide explicit guidance on the future path of interest rates. Instead, it emphasises that future policy decisions will be data-dependent, and the Bank will do whatever it considers is necessary to achieve its mandate of price stability and full employment.
Markets believe that another rate hike could follow this year. For some, this interest rate hike represents “insurance” against sticky inflation, while for others it represents the beginning of a new rate hiking cycle. Nonetheless, it’s the only time since 2008 that the Reserve Bank has lifted interest rates within six months of cutting them, a rare policy reversal that reflects the RBA’s heightened sensitivity to inflation risks.
The expectation of future interest rate rises is largely driven by market expectations that the Reserve Bank will want to ensure that inflation does not rise out of control. However, the balancing act between reducing inflation and maintaining a strong labour market means that the Reserve Bank may be cautious to further lift interest rates too quickly.
This newsletter was distributed on 3rd February 2026. For any questions/comments on this week's newsletter, please contact our authors:
This blog was co-authored by Tom Harding (Associate Director, Deloitte Access Economics) and Leo Saurini (Graduate Economist, Deloitte Access Economics).
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