Australia's central bank sees core inflation stuck above target out past mid-2026

The Reserve Bank of Australia (RBA) has significantly revised its inflation outlook, now projecting core inflation to remain above its 2-3% target band until mid-2026 and not reach 2.6% until late 2027, accelerating to 3.2% by year-end. This upward revision, attributed to stronger economic growth, persistent inflation, a tight labor market, and faster consumer demand and house price appreciation, severely limits the scope for further interest rate cuts. Market expectations have adjusted, pricing out immediate cuts and anticipating only 30 basis points of further easing, a stark contrast to previous forecasts, while the RBA expects stable economic growth around 2% despite a slightly eased but still tight labor market.

Analysis

The Reserve Bank of Australia (RBA) has significantly revised its inflation outlook, now projecting core inflation to remain above its 2-3% target band until mid-2026 and not reaching 2.6% until late 2027. This represents a sharp upward revision, with underlying inflation expected to accelerate to 3.2% by year-end from 3%. The RBA's distinctly hawkish tone signals limited room for further interest rate cuts, with rates widely expected to hold at 3.60%.

This hawkish shift stems from stronger-than-expected economic growth, sticky inflation, a tight labor market, and robust consumer demand, alongside record-high house prices. The RBA noted less economic capacity than previously thought, with the cash rate now below some neutral rate estimates. Market expectations have adjusted, pricing out immediate rate cuts and anticipating only 30 basis points of further easing, a significant change from prior forecasts of rates falling to 2.85%.

While the labor market has eased slightly, the jobless rate is expected to hold steady at 4.4% over the next two years, indicating continued tightness. Household consumption is projected to grow at 2.1%, and home building growth is sharply revised higher to 4.8% by year-end. Despite these factors, the RBA maintains its economic growth forecast around a trend rate of 2%, suggesting a robust global economy is offsetting some domestic pressures.

Key Decisions for Investors

• Investors should assess portfolio sensitivity to higher-for-longer interest rates, particularly in sectors reliant on borrowing or with high debt loads.
• Consider increasing exposure to inflation-protected assets or sectors historically resilient to persistent inflation, given the RBA's revised outlook.
• Given the RBA's hawkish stance and persistent inflation, review Australian dollar currency exposures for potential support.
• Monitor the Australian housing market and consumer discretionary sectors for potential impacts of sustained higher rates, despite current strength.