Big-Picture Snapshot

The RBA’s January 2026 policy rate hike to 3.85% marks a notable shift after a prolonged hold at 3.60% from August through December 2025. This move reverses the easing bias seen in mid-2025, when rates were cut from 4.10% in May to 3.60% by August. The decision reflects the central bank’s renewed concern over sticky inflation, with headline CPI running at 4.20% year-over-year in December 2025, well above the RBA’s 2–3% target band.

Drivers this month

• Headline CPI for December 2025: 4.20% YoY (vs. 4.00% in November)
• Unemployment rate: 4.10% (steady from November)
• Wage Price Index: 3.80% YoY (accelerating from 3.60% in Q3 2025)

Policy pulse

With inflation persistently above target and wage growth accelerating, the RBA’s move aligns with its mandate to anchor expectations. The 3.85% rate is now back to its May 2025 level, suggesting a recalibration rather than a new tightening cycle.

Market lens

Immediate reaction: AUD/USD jumped 0.40% and 2-year yields rose 13 bps within the first hour. Equities dipped as rate-sensitive sectors repriced. Market-implied terminal rate expectations shifted up by 15 bps, signaling belief in further RBA vigilance.

Foundational Indicators

Australia’s macro backdrop entering 2026 is defined by resilient domestic demand, robust labor markets, and persistent service-sector inflation. Real GDP grew 0.50% quarter-on-quarter in Q4 2025, rebounding from 0.30% in Q3. Household consumption, up 2.10% YoY in December, remains a key support, though retail sales growth slowed to 1.20% YoY, reflecting some rate sensitivity.

Drivers this month

• Core inflation (trimmed mean): 4.00% YoY (vs. 3.80% in November)
• Retail sales: 1.20% YoY (down from 1.60% in November)
• Terms of trade: 3.50% YoY, buoyed by iron ore prices

Policy pulse

Fiscal policy remains mildly expansionary, with the government’s mid-year update projecting a 2025–26 deficit of 1.10% of GDP. While fiscal drag is limited, the RBA’s tightening is now the primary macro lever. The policy rate is 85 bps above the 12-month average (3.00%), reflecting a hawkish tilt relative to recent history.

Market lens

Immediate reaction: S&P/ASX 200 fell 0.70% as banks and property stocks led declines. The AUD’s strength reflects both rate differentials and commodity tailwinds, while bond markets now price in a 40% chance of another hike by May 2026.

Drivers this month

• Services inflation: 4.50% YoY (key contributor to CPI upside)
• Unit labor costs: 3.90% YoY (reflecting tight labor markets)
• Housing rents: 5.20% YoY (highest since 2012)

Policy pulse

The RBA’s decision places the policy rate above the 12-month average and signals a hawkish stance relative to G10 peers. The move is calibrated to address second-round inflation effects, especially in services and housing.

Market lens

Immediate reaction: AUD/USD surged 0.40% to 0.73, 2-year yields hit 4.10% (+13 bps), and ASX 200 fell 0.70%. The currency’s rally reflects both the rate surprise and Australia’s favorable terms of trade. Bond markets now price in a 40% probability of another hike by May.

Forward Outlook

The RBA’s January 2026 hike has recalibrated market expectations, with forward curves now implying a 40% chance of another 25 bps increase by May. The central bank’s guidance remains data-dependent, with a focus on wage growth, services inflation, and global commodity prices. Upside risks include further labor market tightening and renewed commodity price shocks, while downside risks center on global growth headwinds and a potential consumer retrenchment.

Bullish, base, and bearish scenarios

• Bullish (25%): Inflation falls faster than expected, allowing the RBA to pause at 3.85% and pivot to cuts by late 2026. AUD strengthens, equities rebound.
• Base (60%): Inflation moderates slowly; RBA holds at 3.85% through mid-2026, with a bias to hike if wage growth accelerates. AUD remains firm, bond yields stable.
• Bearish (15%): Inflation re-accelerates or external shocks (e.g., commodity spike, China slowdown) force further hikes to 4.10%+. AUD volatility rises, equities underperform.

Policy pulse

The RBA’s stance is now clearly hawkish, with the Board emphasizing flexibility and vigilance. Fiscal policy is unlikely to offset monetary tightening, as the government prioritizes deficit containment.

Market lens

Immediate reaction: OIS curve steepened, AUD options volatility rose 8%. Markets are now more sensitive to inflation and wage data, with risk premia rising for rate-sensitive assets.

Closing Thoughts

The RBA’s January 2026 rate hike to 3.85% marks a decisive end to the easing bias of late 2025. With inflation and wage growth still elevated, the central bank has signaled its intent to anchor expectations and prevent a wage-price spiral. Markets have responded with higher yields and a stronger AUD, while equities face renewed headwinds. The policy path ahead remains data-dependent, but the balance of risks now tilts toward further vigilance rather than accommodation.