Australia’s worsening inflation outlook is creating increasingly difficult choices for the RBA. Deputy Governor Andrew Hauser warned that oil prices were approximately one-third higher than assumed in the bank’s August forecasts, while evidence that businesses increasingly regard 3–3.5% inflation as normal has raised concerns about entrenched expectations. Further rate increases could help contain those risks, but would add pressure to a labor market already showing signs of weakness.
Hauser described the inflation outlook as “materially worse” than the RBA projected in August, reflecting elevated energy costs, resilient demand among Australia’s Asian trading partners, AI-related investment and persistent domestic price pressures. Annual headline inflation reached 4.0% in August, well above the RBA’s 2–3% target band. More concerning for policymakers is the possibility that prolonged inflation will change how businesses and households set prices and form expectations. Hauser stressed that monetary policy cannot reverse an external energy shock, but must prevent its effects from becoming embedded in broader inflation expectations.
The difficulty is that previous tightening is already restraining economic activity. Hauser acknowledged that consumption growth remains subdued and the labor market is easing, with September unemployment at a five-year high of 4.7%, somewhat weaker than the RBA had expected. Nevertheless, he emphasized that unemployment remains low by historical and international standards. The policy dilemma is whether to tighten further to contain inflation expectations at the cost of additional labor-market weakness, or allow existing rate increases more time to work while accepting the risk of persistent inflation. Hauser offered no definitive indication of which approach the board would choose.
Markets responded by raising the implied probability of another 25bps hike at the November 3 meeting from around 30% to the low-to-mid-40% range, although a hold remained slightly more likely. A further increase would lift the cash rate from 4.60% to 4.85%, marking the fifth hike this year. The decisive near-term test will be the October 28 Q3 CPI report, particularly whether underlying inflation confirms the deterioration in price pressures or offers reassurance that earlier tightening is taking effect. Stronger-than-expected inflation would reinforce the case for another increase, while softer readings alongside weakening employment could encourage the RBA to wait.
Key Takeaways
- RBA inflation outlook has deteriorated materially: Deputy Governor Andrew Hauser warned that inflation prospects are significantly worse than the bank projected in August. Oil prices are approximately one-third higher than previously assumed, while resilient Asian demand, AI-related investment and persistent domestic cost pressures are complicating the inflation outlook.
- Inflation expectations are becoming a greater concern: With annual headline inflation at 4.0% in August, the RBA is seeing signs that some businesses increasingly regard inflation around 3–3.5% as normal. Hauser warned that allowing expectations to become entrenched could make restoring inflation to the 2–3% target band more difficult and costly.
- Labor market weakness complicates further tightening: September unemployment reached a five-year high of 4.7%, while consumption remains subdued as previous rate increases restrain economic activity. Hauser acknowledged the deterioration but emphasized that unemployment remains low by historical and international standards.
- RBA faces increasingly difficult policy trade-offs: Further tightening could help prevent energy-driven inflation from spreading into broader prices and expectations, but would place additional pressure on employment and consumption. Holding rates would protect the weakening economy while risking more persistent inflation. Hauser described these competing considerations as “hard choices.”
- November rate hike expectations rise sharply: Market-implied probabilities of a November 3 increase climbed from approximately 27–30% to 41–45% following Hauser’s remarks. Another 25bps hike would lift the cash rate from 4.60% to 4.85%, marking the fifth increase this year. However, a November hold remained slightly more likely in the reported pricing snapshots.
- Q3 CPI could determine the November decision: The October 28 quarterly inflation report will provide crucial evidence on whether underlying price pressures are becoming more persistent. Stronger inflation would reinforce the case for immediate tightening, while softer readings alongside weakening employment could give the RBA greater scope to wait.
