Tap-Tap-Tapping on the Brakes

The RBA raised interest rates by 25 bps to 3.85%. It was a unanimous decision.

Recent inflation and employment data were hotter than the surface of the courts at the Australian Open! The RBA had signalled at its last meeting that it might need to raise rates going forward, but the hotter-than-expected data has forced its hand earlier than expected.

“While inflation has fallen substantially since its peak in 2022, it picked up materially in the second half of 2025. The Board has been closely monitoring the economy and judges that some of the increase in inflation reflects greater capacity pressures. As a result, the Board considers that inflation is likely to remain above target for some time.”

“Growth in private demand has strengthened substantially more than expected, driven by both household spending and investment.”

“Financial conditions eased over 2025 and it is uncertain whether they remain restrictive.”

https://www.rba.gov.au/media-releases/2026/mr-26-03.html

What the governor said at the media conference

“The recent run of data gives the Board a clear enough view that the underlying pace of inflation is too strong.”

“Our updated view, driven by the latest data, is that demand was stronger than expected over the second half of 2025 and that some of that strength has carried into 2026.”

“... the economy is closer to its supply capacity than we previously thought, which means supply constraints are binding in some more sectors and it’s not taken much pickup in demand to drive price pressures. Years of weak to no productivity growth is a big part of that story.”

“... we don’t want this higher level of inflation [to be] entrenched.”

“The strategy hasn’t changed here; we are still trying to bring inflation down and keep employment as strong as we can.”

 “Circumstances change; we change.”

“I don’t know if it is a [new tightening] cycle. Certainly, it is an adjustment…”

INXS

The RBA’s fears have been realised.

In September last year, Bullock played down increasing inflation, attributing it to temporary factors. However, she noted that private demand was recovering faster than forecast.

By the next meeting in November, Bullock admitted the possibility that stronger-than-expected private demand was contributing to inflationary pressures, given the existing supply constraints. Could excess aggregate demand be growing again?

“Now, we think that some of this was driven by temporary factors … We are, however, taking signal from stronger price increases that may suggest more inflationary pressure in the economy than we thought before.” Michele Bullock, Monetary Policy Decision Media Conference, 4 November 2025.

Come the February Board meeting, and the fears over excess demand have been confirmed.

“... whereas we thought we might have been at some sort of balance, we don’t think we are now. We think there’s excess demand.” Michele Bullock, Monetary Policy Decision Media Conference, 3 February 2026.

The stronger-than-expected employment report for December and inflation increasing from 3.2% in the September quarter to 3.6% in the December quarter were the two hammer blows that finally convinced the RBA to change its thinking (see chart below).

Loose financial conditions

On top of the admission of excess demand, the RBA also now admits that financial conditions are maybe not as tight as they thought. Bullock and senior staff hinted at the possibility in December, but now they believe financial conditions could actually be loose.

“Finally, financial conditions have eased, and it is uncertain now if they remain restrictive overall.”

“... I think that the Board generally feel at the margin, maybe conditions were just a little bit loose.” Michel Bullock.

Loose credit is supported by recent strong credit growth (see chart below).

Source: RBA Chart Pack

With the triple whammy of excess demand, loose financial conditions, and inflation climbing further from the target band, the Board had no choice but to raise rates now. Bullock even talked about the Board not wanting inflation to become entrenched! We have come 360 degrees from the rate cut in February last year!

“Circumstances change; we change”

Does this mean that the RBA erred with its rate cuts last year? Of course, several versions of this question were asked in the media conference. The answer is no. As Bullock argued in the media conference, the RBA responds to the data in front of it, and this time last year, with the economy slowing and inflation falling, cuts were warranted. She also reminded the room that in the second quarter last year, the RBA had to defend itself against criticisms that they had not cut enough!

From a position of economic strength

However long it takes the RBA to get inflation back under control, it is important to remember that the RBA is starting from a position of strength regarding the other half of its dual mandate. Inflation is increasing because economic growth is too strong and unemployment is historically low.

Of course, if productivity growth had been stronger since the pandemic, maybe Australian demand would not be facing a supply constraint. But given the cards it has been dealt, the RBA would much prefer a slightly overheating economy than facing stagflation.

“The interest rate rise sort of comes across quite negatively. We’re actually in a good position. The labour market is really strong. Domestic demand is recovering. These are good things. But it’s just that we are supply constrained and that we are even a little more constrained than we thought a while ago.”

Australian Private Debt Market

While inflation has reared its ugly head again, the Australian economy remains strong. Further, private debt investors in Australia can continue to enjoy higher rates in Australia for longer, even as rates are paused or falling elsewhere.