A sharper inflation surge has shifted forecasts toward 2026 rate hikes, prompting investors to assess the outlook for yields and bond stability.
Australia’s first monthly inflation reading for the December quarter pointed to a likely overshoot of the Reserve Bank’s year-end projections, with Judo Bank chief economic advisor Warren Hogan and economist Matthew De Pasquale warning that the data had fundamentally altered the monetary policy outlook and brought forward the timing of potential rate hikes.
They said inflation was now clearly moving away from the RBA’s 2 to 3 per cent target band, with core inflation running at a 4 per cent annualised pace since the start of FY26 and headline inflation tracking towards 4 per cent this year.
With activity data showing an economy in recovery, they argued that the central bank may need to tighten policy to stay ahead of building inflationary pressure.
Hogan and De Pasquale both said they had advanced their expectation for the first interest rate rise while keeping the overall tightening cycle at 50 basis points.
They now expected a 25 basis point increase in May followed by another 25 basis point rise in August, which would take the cash rate to 4.1 per cent.
This was contrary to other commentators – such as economists from CBA and ANZ – who expect the RBA will opt to pause, or cut at least one more time.
October’s trimmed mean inflation rose 0.3 per cent over the month and 3.3 per cent over the year. The rolling quarterly change (the measure most aligned with how the RBA interprets trimmed-mean inflation) held at 0.95 per cent between September and October, an annualised 3.8 per cent pace.
The Australian Bureau of Statistics (ABS) revealed that inflation pressures were widespread. Of the 87 CPI components, 40, which represents around 47 per cent of the weighted basket, recorded quarter-on-quarter increases above 1 per cent.
Housing and market services, two segments closely watched by the RBA, showed persistent strength, while core housing inflation had a six-month annualised pace of 4 per cent, while market goods and services rose 1.3 per cent over the quarter.
Judo’s Q4 core inflation forecast has increased to 0.9 per cent, above the 0.8 per cent the RBA projected in its November Statement on Monetary Policy. Hogan and De Pasquale noted higher-than-usual uncertainty given the short history of the monthly inflation series and the potential for larger seasonality revisions.
Meanwhile, financial markets continued shifting toward a higher cash rate.
The three-year rate moved more than 25 basis points above the 3.6 per cent cash rate to 3.88 per cent, while money markets priced a small chance of a rate rise within a year, with a May hike 14 per cent priced in, according to Judo.
In terms of what this means for investors, FIIG Securities head of research Philip Brown said any rate increases were likely to be gradual.
“The RBA won’t want to raise rates too quickly so any rate rises (if they come) would be done relatively slowly,” he said.
He noted that bond yields had already been drifting higher as expectations of cuts faded and the risk of a hike increased, though stability across government and corporate yields had been notable.
“The RBA has managed to take the cash rate from a peak of 4.35 per cent to the current 3.60 per cent and that there is a clear possibility that is the whole cycle if the next move is up – which is looking much more plausible now given the latest CPI results,” Brown said.
The 10-year government bond yield had traded in a relatively tight range — between 4.10 per cent and 4.63 per cent this year — and was sitting around 4.50 per cent. Higher-yielding corporate bonds had also remained steady, according to Brown.
He said that a soft economic landing had reduced the need for “emergency RBA settings”, supporting steadier bond pricing.
If the central bank lifted rates next year, he said bond investors would secure higher income while also benefiting from the more predictable price dynamics that had emerged as pandemic-era distortions faded.
