RBA less hawkish than feared

The RBA kept interest rates on hold yesterday — no surprise there — but the real news was that the accompanying statement wasn’t as hawkish as feared.

If anything, Governor Bullock and her colleagues left the door ajar for rate cuts next year and possibly several more through mid-2027. There was certainly no hint that the next move would be up although, as we’ll see, that risk is no longer negligible.

What appears of most concern, however, was the Bank’s forecast that trimmed-mean inflation will edge back above its 2–3% target band — to 3.2% over the December and March quarters. On the surface, that looks inconsistent with rate cuts, and would seemingly justify rate hikes.

But the apparent contradiction reflects an important need in coming months to distinguish between annual inflation (the lift in prices over the past twelve months) from quarterly or monthly annualised inflation. The former is more widely followed but can be a lagging indicator while the latter provides a timelier signal of current inflation trends.

The RBA considers the higher-than-expected September quarter’s 1% annualised quarterly lift in trimmed-mean inflation partly reflective of ‘temporary factors’ — notably travel, council rates and fuel. But it also conceded part of the surprise lift likely reflected stronger-than-expected underlying inflationary pressure: higher housing and market services costs tied to a rebound in consumer and housing demand.

To reflect these twin forces, the Bank is effectively having a bet each way for the likely rise in underlying inflation in the December quarter – it has revised up its forecast to 0.8% from 0.6%.

As Governor Bullock explained, the higher September quarter outcome along with the upward revision to the December quarter, will “technically” keep annual inflation high for the next few quarters, even if the monthly and quarterly rate of inflation slows back nicely over this period.

Indeed, beyond the December quarter, the RBA’s medium-term inflation outlook hasn’t changed much. The RBA expects 2.65% annualised underlying inflation over the two years to December 2027, up marginally from the 2.6% expectation in August. One reason it’s not higher, despite recent signs of higher underlying inflationary pressure in the September quarter, is because its forecasts now incorporate market expectations of only one further rate cut by mid-2026, compared to the three rate cuts the market expected back in August.

The RBA is effectively betting that underlying inflation momentum will ease from the September quarter’s 4% annualised clip to 3.2% and 2.8% over the December and March 2026 quarters respectively.

Focus on annualised monthly/quarterly inflation – not annual inflation

The bottom line: the RBA could still cut rates next year even as annual trimmed-mean inflation temporarily breaches 3%. What matters is the timelier monthly and quarterly inflation signals. If these drift lower, rate cuts follow; if not, we may be staring at a very short easing cycle — or a surprise hike.

Note that later this month, the ABS will start publishing full monthly CPI reports, offering earlier insights but also potentially more short-run noise. It’s likely the RBA will continue to treat the monthly reports cautiously and take more signal from quarterly trends.

So where to for rates?

It’s now unlikely inflation will convincingly behave quickly enough for the RBA to cut rates in either December or February. But if the RBA’s current forecasts play out, a May rate cut remains plausible — confirming that the September spike was partly a one-off. If not, say if annualised inflation stays well north of 3%, the RBA will have little choice but to hold firm or even tighten.

The labour market will also be key. A rising jobless rate would tilt the RBA toward easing, even with inflation uncomfortably high.

All told, my base case is that quarterly annualised inflation slows in line with RBA forecasts to just under a 3% pace by the March CPI report due in late April, allowing the RBA to cut rates in May. I also now expect a follow up rate cut in August.

In short: it’s a case of rate cuts delayed, not denied. But with some signs that the economy may be more inflation prone than previously thought, further rate cuts are not guaranteed – and there is now some risk rates may need to rise next year.