Big-Picture Snapshot

Drivers this month

Australia’s policy rate for January 2026 was set at 3.85%, up 25 basis points from December’s 3.60% and matching the level last seen in July 2025. The Sigmanomics database confirms this is the first upward move since May 2025, when the rate was also 3.85%. The central bank cited sticky core inflation, robust wage growth, and a resilient labor market as key drivers. Notably:

• Headline CPI inflation for Q4 2025 printed at 4.20% year-over-year, above the 2–3% target band.
• Unemployment held steady at 4.10% in December 2025, near historic lows.
• Wage price index rose 3.80% YoY, accelerating from 3.50% in Q3 2025.

Policy pulse

The 3.85% rate sits above the 12-month average of 3.73%, and is 25 basis points higher than the year-ago level of 3.60% (January 2025). The central bank’s statement emphasized “heightened vigilance” on inflation, with forward guidance remaining data-dependent. Fiscal policy remains mildly expansionary, with the government’s mid-year budget update projecting a deficit of 1.20% of GDP for FY2025/26.

Market lens

Immediate reaction: AUD/USD spiked 0.50% within the first hour after the print, while 2-year yields surged 13bps. Equity markets dipped, with the ASX 200 falling 0.70% on rate-sensitive sectors. Market-implied terminal rate expectations shifted upward, pricing in a 40% probability of another hike by mid-2026.

Foundational Indicators

Macro backdrop

Australia’s economic momentum remains robust, but inflationary pressures persist. GDP growth for Q4 2025 is estimated at 2.10% YoY, moderating from 2.60% in Q3. Retail sales rebounded 1.20% MoM in December, reversing a 0.80% decline in November. Housing prices rose 0.60% MoM, extending a five-month uptrend.

External shocks & fiscal stance

Commodity prices—especially iron ore and LNG—remain elevated, supporting Australia’s terms of trade. However, recent geopolitical tensions in the Asia-Pacific and ongoing supply chain disruptions have added to cost pressures. The government’s fiscal stance is supportive, but with limited room for further stimulus given the projected deficit and rising debt-to-GDP ratio (now 37.50%).

Historical context

• May 2025: Rate at 3.85% (last hike before pause)
• August–December 2025: Rate held at 3.60%
• 12-month average: 3.73%
• Year-ago (January 2025): 3.60%
• April 2020 (pandemic low): 0.25%

Chart Dynamics

Drivers this month

• Core inflation: 4.20% YoY (Q4 2025)
• Wages: 3.80% YoY
• Labor market: Unemployment steady at 4.10%
• Retail sales: 1.20% MoM

Policy pulse

The rate is now 0.25pp above the 12-month average, and 0.25pp higher than January 2025. The central bank’s tone is more hawkish, citing upside inflation risks and global policy tightening.

Market lens

Immediate reaction: AUD/USD jumped 0.50%, 2-year yields rose 13bps, and ASX 200 fell 0.70%. The move surprised consensus, which had expected a hold. Market pricing now implies a 40% chance of another hike by June 2026, with swaps markets adjusting upward across the curve.

Forward Outlook

Scenario probabilities

• Bullish (25%): Inflation moderates faster than expected, allowing a pause or even a cut by late 2026. Growth remains resilient, and AUD strengthens.
• Base case (60%): Policy rate holds at 3.85% through mid-2026. Inflation gradually converges to target, but risks remain skewed to the upside.
• Bearish (15%): Inflation proves sticky, forcing another 25bp hike by Q3 2026. Growth slows, unemployment rises, and risk assets underperform.

Risks and catalysts

Upside risks include further supply shocks, wage acceleration, and commodity price spikes. Downside risks stem from global slowdown, China demand weakness, or a sharp correction in housing. Fiscal slippage could also complicate the inflation outlook.

Market lens

Immediate reaction: AUD/USD’s rally may persist if inflation data remains hot, while equities could face further pressure. Bond yields are likely to stay elevated, with the yield curve flattening as markets price in a higher-for-longer scenario.

Closing Thoughts

Structural & long-run trends

The January 2026 rate hike underscores the central bank’s resolve to anchor inflation expectations. While the economy remains resilient, the cumulative impact of higher rates will test household and business balance sheets. Long-run productivity, demographic headwinds, and external shocks will shape the policy path ahead.

Policy pulse

With the policy rate now at a post-pandemic high, the central bank is signaling a bias toward further tightening if inflation fails to moderate. Fiscal and structural reforms will be critical to sustaining growth as monetary conditions tighten.

Market lens

Immediate reaction: Risk assets are likely to remain volatile as markets digest the hawkish shift. Investors should monitor inflation prints, wage data, and global developments for clues on the next policy move.