The markets price in a likely RBA hike as Australian inflation accelerates

The Reserve Bank of Australia is forecast to hike the overnight cash rate to 3.85% at its first meeting of 2026.

Markets price in RBA hike as inflation rises above target

The rates markets imply the RBA is likely to hike interest rates when it meets for the first time this year. Currently, the cash rate futures curve implies a 72% probability of a hike.

(Source: Bloomberg, Capital.com)

The odds of a rate rise have lifted following a spate of CPI data revealing Australian inflation has risen above the RBA’s 2% to 3% target band. Price data for December showed headline price growth picked up to 3.8%, exceeding economist expectations. The RBA’s chosen inflation measure, the trimmed mean CPI, came in as expected but still showed a rise to 3.3%.

Most concerningly, the most CPI data pointed to accelerating services inflation – prices most sensitive to consumer demand, household activity and interest rate settings. It lifted to 4.1%, largely supported by existing rate cuts and expansionary fiscal settings.

Despite moderate GDP growth, the most recent Australian labour force data signalled the labour market is no impediment to hiking rates. The figures for December showed a plunge in the unemployment rate to 4.1% on a stronger than forecast 65,200 employment change for the month.

The RBA is tipped to revise higher its inflation forecasts

The RBA updates its Statement on Monetary Policy at this meeting and is expected to revise upwards its inflation forecasts. It’s also possible that it revises its unemployment rate forecasts lower.

The central bank’s November SOMP was noteworthy for aggressively revising higher inflation projections, with headline inflation and trimmed mean inflation projected to rise to 3.7% and 3.2% respectively by the middle of 2026. The forecasts also implied headline inflation would stay above target until the middle of 2027 and trimmed mean would remain above target until the end of the year. Given inflation is already running above those forecasts and with risks to prices skewed to the upside, the RBA is in the position to revise its estimates higher again and potentially guide the markets towards future rate hikes.

(Source: ABS)

AUD/USD exposed to two-way risks around this RBA decision

The AUD/USD is in an uptrend heading into the RBA decision as traders price in a rate hike along with the impacts of rising global commodity price and some downside in the US Dollar. The currency confronts two-way volatility at this RBA meeting. A hike will see the markets being forced to price in the seven points of hikes currently not implied in the curve and supporting the AUD/USD. Meanwhile, a hold would see 18 points of cuts currently baked in come out of the curve and weigh on the pair.

The forecasts provided by the RBA will also be critical to the AUD/USD and the shape of the futures curve. Upwardly revised forecasts may bring forward the timing of any future hikes, adding a tailwind to the pair.

From a technical point of view, the AUD/USD has pulled back from extraordinarily overbought levels on the daily RSI after hitting a three year high at nearly 0.7100. That level now represents short-term resistance, with a break indicating a continuation of the primary uptrend. Meanwhile, support could be found around 0.6900, with a break potentially signalling further downside risk.

(Source: Trading View)
(Past performance is not a reliable indicator of future results)