Reserve Bank of Australia lifts cash rate to 18-year high

The Reserve Bank of Australia raised the official cash rate by 25 basis points to 4.85% in a 6-3 board vote, taking it to its highest level in 18 years.

Ivan Colhoun, Chief Economist at CreditorWatch, said the increase had been widely expected after recent messaging from senior central bank officials and stronger-than-expected inflation data. The latest quarterly trimmed mean consumer price index reading of 1%, he said, had pushed back the expected return of inflation to target by six months.

That means the Reserve Bank's updated forecasts now show core inflation returning to target in the first half of 2028. Colhoun said inflation staying at 2.9% or above throughout 2027 suggested policymakers may still face pressure to do more.

"RBA Board votes 6-3 to raise the official cash rate 25bps. This takes interest rates to 18-year highs and is likely to be the last rate rise for some time," Colhoun said.

He said the decision followed a run of official warnings that inflation remained too high and that some businesses were starting to doubt the central bank would return inflation to target. In his view, failing to tighten policy at this meeting would have delayed that process further.

The revised central bank forecasts also point to a longer period of weak growth. Colhoun noted that growth for 2027 had been revised down to 1.3% from 1.6%, reflecting the Bank's view that slower economic activity is needed to bring inflation back under control.

Growth outlook

Colhoun said the forecasts also showed a gradual rise in unemployment, with rates of 5% and 5.1% projected in 2028. He argued that the make-up of any increase would matter, particularly whether it came from a larger labour force or from more people losing their jobs.

"A period of even slower growth in prospect over the next two years, which the Bank believes is needed to help lower inflation to target. Growth for 2027 has been revised down from 1.6% to 1.3%," Colhoun said.

He also questioned the labour market data used as the starting point for those forecasts. Colhoun said he remained sceptical about the Australian Bureau of Statistics' most recent unemployment estimates and expected some retracement in the months ahead.

"A continuing slow rise in the unemployment rate - the media is likely to seize on the 5% and 5.1% unemployment rate forecasts in 2028. It's important whether that forecast is a result of more joining the labour force, which has been the trend of recent periods, or more people losing their jobs. I remain sceptical of the ABS's latest reported unemployment rate estimates, which the RBA has had to use as the starting point for these forecasts and expect some retracement (decline) in coming months. As in previous forecasts, it's a very slow forecast increase in unemployment," Colhoun said.

Inflation risks

Colhoun said the longer path back to target inflation may leave the Reserve Bank with limited room to relax its stance soon, even though he does not expect another immediate rise. He said the board's language pointed to upside risks to inflation expectations.

He also argued that the central bank's forecasting models were not well suited to the number of large forces affecting the economy at once. He listed artificial intelligence investment, geopolitical tensions, conflict in the Middle East, wage decisions, slower migration, population ageing and climate pressures linked to El Nino among the factors clouding the outlook.

"The important core rate of inflation forecast now returns to target in the first half of 2028, six months later than previously. With core inflation 2.9% or above throughout 2027, this might suggest the RBA has some more work to do - the Decision does warn of upside risks to inflation expectations as a result," Colhoun said.

Pause expected

Despite that warning, Colhoun said he expected the Reserve Bank to leave rates unchanged for at least the next few months while it assessed the effect of cumulative tightening. He noted that the central bank has now tightened policy in back-to-back moves and by a total of five times over 2026.

The 6-3 split may be read by markets as a sign that a pause is more likely, though Colhoun said there was still likely to be a core group of board members aligned with the Bank's recommendation. He added that central bank communications often take on a more hawkish tone when rates are rising and a more dovish tone when policy is being eased.

"My expectation is that after tightening back-to-back and now by a total of five times over 2026, the RBA will now leave cash rates unchanged for some months - at least until February, and probably longer - while it assesses the impact of this considerable tightening on the economy. The 6-3 majority decision might seem like it makes this more likely, however, there is still likely a core group of Board members that mostly follows the RBA's recommendation. It's worth remembering the RBA always sounds hawkish when it tightens and dovish when it eases," Colhoun said.