The economic ground shook on Wednesday after the Bureau of Statistics released its new monthly Consumer Price Index (CPI) data.
It showed inflation isn’t behaving itself.
Headline inflation came in at 3.8 per cent, while underlying or core inflation was at 3.3 per cent.
The Reserve Bank wants inflation “sustainably” within its target range of between 2 and 3 per cent, and ideally at the midpoint of that range (2.5 per cent).
Inflation had seemingly settled slightly above that midpoint earlier this year.
But it appears to have been a mirage.
It means there is now a realistic chance of a Reserve Bank interest rate hike in the next six months.
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It’s an extraordinary turnaround in interest rate expectations.
Markets had been pricing in a small possibility of a November interest rate cut, which didn’t eventuate, after a spike in the September jobless rate to 4.5 per cent.
Few, if any, economists were expecting an early 2026 interest rate cut.
What’s with higher inflation?
Anyone watching their budget won’t be surprised by the higher inflation result.
They know. They’ve copped the energy bill shock, or the heart-sink rental price increase.
Bureau of Statistics data show annual goods inflation was 3.8 per cent, up from 3.7 per cent, in the 12 months to September.
The main contributor was electricity (up 37.1 per cent in the 12 months to October), influenced by the winding down of government rebates.
The cost of electricity was a significant factor in rising inflation. (ABC News: Andrew O’Connor)
Rents rose 4.2 per cent in the 12 months to October, following a 3.8 per cent rise in the 12 months to September.
New dwelling prices rose 1.7 per cent annually, up from a 1.5 per cent rise a month earlier.
But something else is going on here.
An economy bursting?
To get to the heart of this inflation frustration, we must get a bit abstract.
The Reserve Bank says it doesn’t know for sure, but it believes aggregate demand in the economy exceeds aggregate supply.
Economics textbooks tell you when demand exceeds supply, prices rise.
“Inflation isn’t back because of what is or isn’t happening to taxpayer subsidies for things like electricity,” independent economist Chris Richardson says.
“Inflation is back because, even though the Australian economy isn’t travelling fast, its clapped-out engine is already moving faster than we can safely travel.”
He takes the engine analogy further.
“With our engine clogged by poor productivity, we’re already back where we were a while ago — with inflation bouncing as too much money chases too little stuff.
“There’s no easy solution to that.”
Amid the drive for more housing, the cost of new dwellings is on the upswing. (ABC News: John Gunn)
When demand pressure builds up in a healthy economy, smart businesses find ways to expand and produce more, taking pressure off the need to hike prices.
Indeed, businesses find they make more money because the extra goods they make, at lower cost (because they’re more productive), are demanded by more customers.
Australia’s not a healthy economy in relation in this respect — when the economy eats too much, it gets reflux.
Interest rate antidote
If the economy won’t expand to absorb the higher demand, guess what … demand needs to fall.
Cue the potential need for what was unthinkable just a month ago: an RBA rate hike.
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This week saw several investment banks and commercial banks forecast the next move by the central bank would be to hike interest rates.
“With growing evidence that the economy is close to bumping up against capacity constraints, we are confident in calling the RBA easing cycle as over,” the NAB said.
“But the soft-landing dictates that any acceleration in growth and/or a tightening of the labour market from here will likely force the RBA to contemplate the need for rate hikes, possibly as soon as [the first half of 2026].”
In other words, the bank is saying the RBA could increase interest rates anytime from February next year.
Investment bank Barrenjoey sees an “uncomfortable persistence” to housing inflation (which includes rents and the cost of building a new home), and services inflation.
This, it says, “makes it difficult to see trimmed mean inflation moving sustainably to 2.5 per cent, suggesting that the last mile of inflation will likely require tighter monetary policy settings”.
“We now think the next move from the RBA is a rate hike, in May,” Barrenjoey said.
HSBC published a note this week saying its “central case” was the RBA leaving interest rates on hold throughout 2026, with “rate hikes beginning in early 2027” but that interest rate hikes could “come earlier than that”.
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JP Morgan continues “to see the RBA on hold through 2026, with hikes likely from early 2027” and Oxford Economics says simply that the October monthly CPI data “opens the door for a hike”.
Money markets are pricing in no change for the December 9 RBA interest rates decision.
But Bloomberg data show the chance of interest rate hikes increasing by May, with a 40 per cent chance of an RBA rate hike in November and a coin toss for the December decision.
Of course, all these forecasts could be thrown out if global financial markets melt down or Australia’s unemployment rate spikes north of 4.5 per cent.
Any serious threat to the Australian economy would see the RBA pivot back to easing monetary policy.
Mortgage borrowers pay the price
A quarter of a percentage point interest rate increase adds roughly $75 to monthly repayments on a standard variable loan with a $750,000 balance, over a 25-year term.
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It’s a straightforward way of reducing the purchasing power of, and demand from, millions of Australian households.
The alternative is to boost productivity, providing the economy with breathing room to grow and expand.
The price for the nation’s ongoing poor levels of productivity is being paid, in large part, by mortgage borrowers.