From Adam Bowe, Executive Vice President and Head of Australia Portfolio Management at PIMCO.
The RBA raised the cash rate by 25bp to 3.85% which had been largely expected by the market following recent inflation and employment data.
Inflation rose above the RBAs 2-3% inflation target in the second half of 2025, with the y/y headline rate finishing the year at 3.8%. Although several factors contributing to the strength appear temporary and not directly impacted by monetary policy, such as the 0.5% contribution from electricity prices, the RBA judged that monetary policy was not restrictive enough to bring inflation back to target over a reasonable timeframe.
What does it mean
Recent inflation and employment data has been very volatile which makes discerning signal from noise very challenging at this juncture.
What we do know is that the improvement in GDP growth last year was driven by a pick-up in household consumption. Given high household leverage and the fact that the percentage of household incomes being dedicated to tax and mortgage payments remains near all-time highs, the durability of the consumption improvement is questionable with a higher cash rate.
What next
The volatility of recent inflation and employment data, in conjunction with a household balance sheet that is highly sensitive to interest rates, suggests a cautious approach to monetary policy over coming months.
We consider the current cash rate as restrictive, and expect that overtime it will cool demand and bring inflation back into the 2-3% target band. If RBA chooses to tighten policy modestly further to bring inflation down more quickly we do not think they will need to lift the cash rate to the prior peak of 4.35% given the modest overshoot in inflation this time.
With the market pricing the cash rate back above 4% and yields on 10 year Australian Commonwealth Government Bonds reapproaching the highs of the past 15 years we think there is considerable value in Australian duration.
