Kiss your rate cuts goodbye? Why the RBA may not cut rates again this cycle

The shorter line is part of the implied yield curve that existed at the start of 2025. It’s shorter than the others because data for the curves is provided for 18 months into the future, and naturally since January, 8 months have rolled off compared to where the other, newer curves start.

The January implied yield curve shows us that at the start of the year, markets were forecasting the OCR would be 3.68% by this month. It is of course 3.60% after the RBA’s last 0.25% or “25 basis point (bp)” cut on 12 August. So, considering all of the variables that we started 2025 with – a still largely uncertain inflation picture and a slowing domestic economy – markets pretty much nailed where the OCR would be nine months down the track.

But, that’s only up until roughly this month, because if we look at the rest of January’s curve, markets were forecasting the OCR would bottom out at 3.50%. The point where the implied yield curve bottoms and flattens out is referred to as the “terminal rate”.

Given the terminal rate at the start of the year was 3.50%, we say that the market was at the time pricing a 40% chance of a cut in the OCR to 3.35%. We can assume this because the RBA typically moves in 25 bp increments or decrements, so a reading of 3.50% in the implied yield curve – which is 10 bp from 3.60% towards 3.35% – implies a 40% chance of a cut to the lower value (10 bp / 25 bp = 0.4!).

I wanted to show you this older curve because it demonstrates two things. Firstly, markets are usually pretty good at predicting where the cash rate is going to be in the near future – after all that’s why the analysts at the big broking firms get paid the big bucks! But secondly, it also shows that circumstances can change to cause the market’s expectations to shift. The more significant the change, the more significant the shift in expectations.

Since January, we’ve seen the rate of inflation in Australia as measured by the consumer price index (CPI) fall at a faster rate than originally expected. This has allowed the RBA to cut interest rates more aggressively than the market was anticipating back in January. It also explains why January’s forecast for the middle of 2026 is so at odds with the current forecast – that’s the darkest green line.

The “current” forecast for the OCR is for two more 25 bp cuts to 3.10% by July next year. To be totally accurate, given the current implied yield curve bottoms out at 3.11%, it actually means the market is forecasting a 96% chance of a second cut to the OCR in July 2026. FYI, the next 25 bp cut to the OCR to 3.35% is currently forecast for December, as this is the first month the current implied yield curve sits completely below 3.35%.

I expect you’ve also noticed that the current implied yield curve is higher than where it was a week ago, and quite a bit higher than where it was 3 weeks ago, immediately after the RBA’s August Board meeting and accompanying OCR cut. If we consider the trough of the post-meeting implied yield curve was 2.98% in July 2026 (yes, a “2” at the start), we can see that the market has pared back 13 bp of cuts to the OCR, or just over half a typical rate cut.

We’ve already noted that expectations can and do change – by 50 bp since just the start of the year. So what’s caused this recent jump in the market’s forecast terminal OCR, and could it signal the start of a broader move… One that could wipe out any further cuts, if say, we see a similar move in the opposite direction to what’s occurred since January? 🤔

Kiss your rate cuts goodbye?

If the terminal rate were to rise 50 bp over the next 8 months, then it would completely wipe out and more cuts to the OCR. This is a frightening prospect for investors and mortgage holders alike! Let’s investigate some of the reasons why the market’s forecast for the terminal rate has risen so sharply since the August RBA Board meeting, and try to determine if it could continue to threaten the further two 25 bp cuts that are presently baked in (okay, 96% baked in for the second one!).

The main catalyst for the market’s recent repricing of the terminal rate was the release of June quarter GDP figures. The Australian economy grew by 0.6% over the quarter, 1.8% over the year, and if maintained – at an annualised pace of 2.4% per annum. This was faster than economists expected, and the general rule of thumb is that a faster growing economy usually leads to higher inflation. That’s where it hurts the prospects for further interest rate cuts – the RBA doesn’t want to see another spike in inflation – certainly, they won’t want to cut the OCR any further if they do.

Of particular interest among economists was the strength in household spending, the largest component of the GDP calculation. Major broker UBS in a research note covering the GDP data noted that “real GDP in Q2-25 supported our view that a modest recovery is underway,” with that recovery likely to “remain supported by the large boost from RBA easing and strong household wealth which is supporting consumption”.

RBC’s Su-Lin Ong also covered the GDP data, and noted that stronger real household incomes which rose 5 per cent over the year – the fastest pace outside the pandemic and global financial crisis era are underpinning the consumer revival – are underpinning a consumer revival. Higher real incomes just means Aussies are feeling more wealthy because inflation is falling, leaving them more disposable income. And they’re spending it!

Stronger consumer demand sounds positive, but as noted before, it also raises alarm bells for policymakers. UBS flagged that productivity growth remains close to flat while unit labour costs – essentially the wages businesses pay relative to output – are still running at more than 4% per annum. That level is “probably too high for CPI to sustainably remain around the RBA’s target,” UBS warned (the RBA’s target inflation rate band is 2-3% per annum).

RBC struck a similar tone. Ms. Ong noted that employee compensation is still growing at 6.7% per annum, with public sector wages growing at an even higher 7.5% per annum clip. “Neither are consistent with mid-point inflation over the medium term,” she wrote.

I’ll finish this part of the discussion with a UBS forecast that suggested flat productivity would act as a handbrake on what the Australian economy could produce without triggering higher inflation. “We still look for a further pick-up in 2026 to 2.1% [per annum GDP growth]. This is close to 'potential' growth, which declined to ~2% y/y; dragged by flat productivity”. Translation: UBS thinks the Australian economy will grow faster than what it can accommodate without stoking inflation.

The major part of the productivity puzzle is that businesses are refusing to commit to investing in the tools, systems, and infrastructure to jumpstart productivity across the Australian economy. Both UBS and RBC noted that business investment is stagnating at just over 9 per cent of GDP, its lowest since early 2023. That leaves the local economy vulnerable: If consumer demand keeps rising but firms fail to expand capacity – inflationary bottlenecks could emerge very quickly.