Australian inflation surges – interest rate hike looms

Inflation has risen further above the Reserve Bank of Australia’s 2–3% target. There is now a very real prospect the Reserve Bank will feel it needs to increase interest rates at its meeting next week, with an announcement due on Tuesday afternoon.

Inflation rose 3.8% in the year to December, up from 3.4% in the year to November, according to the latest Australian Bureau of Statistics consumer price index (CPI) report.

The Reserve Bank will look at the data for the December quarter at its February 2-3 meeting.

Financial markets and economists had been leaning towards the possibility of an interest rate rise, as inflation proved stubbornly high in recent months and the jobs market picked up. Today’s inflation data has led markets to regard an interest rate increase as more likely.

Where prices moved the most

Comparing prices in the December quarter of 2025 with the same period in 2024, strong rises were recorded for beef and veal, up 10.7%, reflecting strong overseas demand for Australian red meat.

The ending of rebates saw electricity prices rise 26%, reversing previous sharp declines. The cost of child care was up 11.3%. The prices of some food items, such as pork, poultry, seafoods and cheese, were little changed over the year. So were prices of furniture and pharmaceuticals. But very few goods and services showed significant price falls.

The Reserve Bank’s preferred indicator for the underlying trend in inflation is the “trimmed mean”, which takes out items with the most extreme price changes. This measure was 3.4% in the December quarter, up from 3.0% in the September quarter.

This is significantly above the top of the target range and almost 1% above the mid-point of the range, which is where the central bank would like to see inflation. It is also above the RBA’s most recently published forecast.

This measure of underlying inflation initially dropped rapidly from its 6.8% peak at end of 2022, once the Reserve Bank started raising interest rates. Progress in returning to the target range, unsurprisingly, slowed going into 2025. But inflation has now risen again.

The International Monetary Fund recently warned Australia is “projected to see some drawn-out persistence in above-target inflation”.

But another international body, the Organisation for Economic Co-operation and Development, was more optimistic, commenting “if, as expected, inflation turns back down during 2026, there may be some space for further easing” in interest rates.

The more volatile monthly series

As well as the long-running quarterly series, the Bureau of Statistics has recently published monthly data. The December 2025 data is only the third complete monthly CPI issued.

Previously, the monthly update was called an “indicator” because it covered fewer goods and services than the long-running quarterly CPI report.

But the complete monthly CPI is not only new, it is also more volatile than the long-running quarterly series. So this increase in reported inflation needs to be interpreted with care.

As you can see from the chart above there have been periods such as August–September 2023 when the monthly measure briefly spiked up but inflation was still on a downward trajectory. So the annual increase of 3.8% in December may be exaggerating the problem.

Why the latest jobs data matters too

The recent jobs data showed a very healthy labour market. About 65,000 more people were employed in December than November. The unemployment rate dropped from 4.3% to 4.1%.

Low unemployment is a good thing. Indeed, full employment is explicitly an objective of the Reserve Bank.

The RBA would only be concerned about lower unemployment if they thought the labour market was overheating and causing inflationary pressures. Wages growth has been 3.5% or less for the past year. The RBA’s latest forecast is for it to slow to 3%. If labour productivity can grow close to 1%, as the bank expects, that would be consistent with inflation around the middle of the RBA’s 2–3% target range.

Nor is the latest annual growth in the economy, around 2%, indicating an economy that is overheating.

What it all means for interest rates

The increase to 3.4% in the RBA’s preferred measure of underlying inflation means the bank will seriously consider lifting its key interest rate, the “cash rate”.

This would be an unusually rapid turnaround after the recent interest rate cuts. Generally, the RBA will hold rates steady for a longer time – perhaps a year or so – before reversing course.

The Reserve Bank would want to be sure there has truly been a sustained increase in the inflationary pressures in the economy, or that they had earlier been underestimating them.

The central bank would want to avoid a situation where, after cutting rates last August, it raised them again in February – then had to cut again soon after if the economy slowed again.

John Hawkins, Head, Canberra School of Government, University of Canberra

This article is republished from The Conversation under a Creative Commons license. Read the original article.