Interest rate cuts are likely over as Reserve Bank hints at a potential for increases to recommence

The Reserve Bank has dramatically shifted its tone on interest rates, warning that it may need to raise the cash rate as soon as February after inflation proved more stubborn than expected.

Homebuyers who had been expecting a cut to mortgage rates in 2026 have had their hopes dashed.

Just six months after the Reserve Bank began cutting interest rates, governor Michele Bullock delivered an uncomfortable message to Australian households: the next move in rates could be up, not down.

In a remarkable reversal, the RBA acknowledged that “the risks to inflation have tilted to the upside” after recent data showed price pressures were more persistent than had been hoped.

The shift in tone was stark. The board didn’t even consider a rate cut at Tuesday’s meeting. Instead, it discussed the circumstances which might force it to raise rates next year.

“We didn’t consider the case for a rate cut at all,” Ms Bullock told reporters.

“There was no cut on the table, and no one suggested that there be a cut.”

The warning pushed the ASX 200 stock index down 0.5 per cent to a five-day low of 8585.9 points.

Stocks fell as the money market priced in three 25 basis-points increases by August – a move which would result in the cash rate rise fully unwinding the easing from 4.35 to 3.6 per cent since February.

If interest rate cuts are over, this will have been the shortest interest rate cutting cycle ever.

The Australian dollar tested its highest levels in about three months – around US66.50c – as Australian commonwealth government bond yields hit their highest points in over a year.

The 10-year bond yield rose 5 basis points to 4.76 per cent.

Economists scrambled to revise their forecasts, with some predicting a rate rise by February.

“The pick-up in momentum has been stronger than anticipated, particularly in the private sector,” the RBA said in its statement. “If this continues, it is likely to add to capacity pressures.”

In other words, if demand keeps growing at this pace, businesses will find it easier to put up prices.

RBA governor Michele Bullock after Tuesday’s monetary policy decision. Picture: Christian Gilles

The critical test will come on January 28 when the December quarter inflation figures are released, just days before the RBA’s next meeting in February. If that data shows inflation accelerating again, rather than falling back as the bank hopes, a rate rise could be on the cards.

Ms Bullock made it clear the bank would not hesitate to act if it were needed. “If inflation pressures look to be more persistent, then the board might have to consider whether or not it’s appropriate to keep interest rates where they are, or, in fact, at some point raise them,” she said.

She pushed back hard against suggestions the board would be reluctant to reverse course so soon after cutting rates. “When things change, you have to change your view,” she said. “It’s appropriate that the board is agile and nimble.”

She also effectively ruled out further rate cuts in the “foreseeable future”, saying: “I don’t think there are interest rate cuts on the horizon.”

For mortgage holders who have appreciated the three rate cuts this year totalling 0.90 percentage points, this is a bitter pill. The average variable mortgage rate has fallen from around 6.5 per cent to 5.6 per cent.

Those gains could be reversed if rates rise again.

Not everyone is convinced a rate rise is coming.

AMP chief economist Shane Oliver expects rates to stay on hold through 2026, arguing that rising unemployment and fragile consumer spending will keep inflation in check.

“The risks are now more on the upside,” he concedes, “but the swing to expecting rate hikes is premature”.

AMP chief economist Shane Oliver.

But Capital Economics predicts the RBA will start raising rates in February and lift the cash rate to 4.10 per cent by May.

“This would be a risky strategy” to sit out the current strength in inflation, said its head of APAC, Marcel Thieliant, noting capacity constraints and a tight labour market.

NAB chief economist Sally Auld still expects the RBA to keep interest rates on hold next year.

But after Tuesday’s RBA communications, she said: “February is now a live meeting for a rate hike.”

The RBA’s predicament highlights the difficulty of managing an economy that avoided recession during the pandemic but now risks overheating as it recovers.

The bank raised rates 13 times in 2022 and 2023 to combat inflation, then cut three times this year as price pressures appeared to ease. Now it may have to reverse course again.

Ms Bullock tried to explain the challenge. “It gets harder as we get closer to neutral on the interest rate and as we get closer to balance on the economy,” she said.

“Jumping at one number would not be the appropriate thing to do.”

But she also made it clear the board’s focus has shifted.

“The risks now are on the upside, particularly with some of the downside risks abating a little bit,” she said. “Their focus now has moved much more towards inflation.”

The next six weeks will be crucial. If the November and December inflation data confirms the upward trend, Australian households could be facing higher mortgage rates by Easter.

If not, the RBA may yet avoid the awkward position of having to unwind its own rate cuts.

Either way, the brief era of falling interest rates appears to be over.

The question now is whether rates simply stay put, or whether they’re heading higher.

Originally published as Interest rate cuts are likely over as Reserve Bank hints at a potential for increases to recommence