Farewell rate cuts, we hardly knew ye

After three rate cuts in 2025, the RBA have wasted no time this year in dashing hopes of further rate relief in 2026. 

While lower unemployment and the January inflation print year meant Tuesday's unanimous decision to raise the cash rate to 3.85% was a relatively sure thing, it's an about-turn that will raise more questions about where exactly the Australian economy finds itself. 

As RBA Governor Michelle Bullock was keen to stress in Tuesday's press conference, "this is not a science, it’s a bit of an art, really, and there’s so many things that can push you off course."

The Australian dollar jumped above US$0.70 again, and the ASX 200 closed positive, even if it gave up some intraday gains.

In its statement, the RBA pointed to an uptick in private demand as one of the key drivers of its decision.

"Growth in private demand has strengthened substantially more than expected, driven by both household spending and investment. Activity and prices in the housing market are also continuing to pick up. Financial conditions eased over 2025 and it is uncertain whether they remain restrictive."

Worryingly, the RBA now forecasts that inflation won't be back in the target range of 2-3% until June 2027, and not back to 2.5% until 2028. 

To compound the worry, GDP is forecast to drop to 1.6% by 2027, and household consumption could drop to 2.1% by the end of this year, even as inflation persists. 

While the feeling in the room was that this is a hawkish hike, with the understanding that more hikes are on the way, Bullock herself took a slightly more optimistic view. 

While she conceded rate hikes come across "negatively", she was keen to stress that the country was "actually in a really good position".

She was also adamant that a 50bps hike was never a consideration, but admits the RBA is not ruling out further hikes. 

Despite Bullock's conciliatory tone, Betashares' chief economist David Bassanese believes the RBA is setting the stage for more rate rises. 

“It’s hard to avoid the conclusion that the RBA has in mind at least one more rate hike – consistent with current market pricing – because even under this scenario inflation is expected to remain uncomfortably high for the foreseeable future,” Bassanese said.

Adam Bowe, PIMCO's Head of Australia Portfolio Management, suggests we should expect a "cautious approach to monetary policy over coming months." 

But he says the cash rate could prove enough to bring inflation down as required. "We consider the current cash rate as restrictive, and expect that over time it will cool demand and bring inflation back into the 2-3% target band," said Bowe.

"If the RBA chooses to tighten policy modestly further to bring inflation down more quickly we do not think they will need to lift the cash rate to the prior peak of 4.35% given the modest overshoot in inflation this time."

The upshot for investors is attractive yields in government bonds.

"With the market pricing the cash rate back above 4% and yields on 10-year Australian Commonwealth Government Bonds re-approaching the highs of the past 15 years we think there is considerable value in Australian duration."