The Reserve Bank of Australia raised the cash rate by a quarter-point to 3.85% at today’s meeting.
The decision was widely expected, but the Australian dollar nevertheless gained 1.4% on Tuesday. This was the RBA’s first rate hike since November 2023 and marks a sharp departure from the Bank’s accommodative monetary policy—the RBA cut rates three times in 2025 when inflation was easing.
RBA: Higher Inflation Required Rate Hike
Not surprisingly, the RBA pointed to inflation, which has been moving higher lately, as the reason for the rate hike. Trimmed mean inflation, the RBA’s preferred inflation indicator, rose to 3.3% year-on-year in December, up from 3.2% in November. This remains above the RBA’s target band of 2–3%.
The rate statement noted that inflation had “picked up materially” in the second half of 2025. The board said that “inflation is likely to remain above target for some time and it was appropriate to increase the cash rate target.”
In her follow-up press conference, Governor Michelle Bullock was surprisingly blunt, noting that “based on the data, the board now thinks it will take longer for inflation to return to target and this is not an acceptable outcome.”
The RBA is clearly uncomfortable with the upside risk to inflation. The Bank released its updated inflation forecast today, indicating that inflation will not fall back to the 2–3% target band until June 2027. This is longer than previously thought, and RBA members felt they had no choice but to resort to a rate hike in order to keep inflation in check. The Bank is hoping that a modest rate hike now will reduce the need for more aggressive action later.
What can we expect next from the RBA? That will depend largely on whether inflation—particularly services inflation—starts to cool and whether wage growth shows signs of easing. If the economy continues to heat up and inflation moves higher, further rate hikes are likely in the coming months.
Australian Dollar Surges Higher
The AUD/USD currency pair had a strong session, climbing 1.4% to trade at $0.7045. While today’s rate hike was not a surprise, investors clearly liked the RBA’s message, sending the Australian dollar sharply higher.
Stock Markets Post Strong Gains
The S&P/ASX 200, Australia’s benchmark stock index, climbed sharply on Tuesday following the RBA’s rate hike. The index closed at 8,857.10, up 78.50 points, or 0.89%.
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