Inflation surge forces rethink of economic outlook, Reserve Bank warns
The Reserve Bank of Australia has warned inflation rose more sharply than expected in late 2025, prompting revised forecasts and raising the likelihood that interest rates may remain higher for longer.
In a speech delivered in Sydney on Tuesday, the central bank’s Head of Economic Analysis Michael Plumb said inflation accelerated unexpectedly in the second half of last year, driven by stronger demand, housing and retail pricing changes, and persistent capacity constraints across the economy.
Headline inflation reached 3.6 per cent over the year to the December quarter, while underlying inflation climbed to 3.4 per cent—both above the central bank’s 2–3 per cent target range.
Strong demand fuels price pressures
The central bank attributed the inflation rebound partly to sector-specific price increases, including travel, fuel, housing and retail, though many of these pressures are expected to ease in coming months.
However, broader economic conditions also contributed. Stronger-than-expected consumer spending, business investment and exports helped push demand beyond the economy’s supply capacity, intensifying inflationary pressures.
Mr Plumb said improved household incomes, resilient global economic conditions and increased investment in sectors such as data centres and energy supported growth.
“Demand picked up by more than we thought,” he said, noting domestic financial conditions may have been less restrictive than previously assessed.
Interest rate outlook shifts higher
In response, the central bank has revised its forecasts, assuming a higher path for interest rates to contain inflation and bring demand back into balance.
The bank expects inflation to peak in mid-2026 before gradually declining, reaching around the midpoint of its target range by mid-2028 as economic growth slows and capacity pressures ease.
The outlook reflects the bank’s expectation that tighter financial conditions and slowing growth will help reduce price pressures over time.
Capacity constraints remain a concern
The central bank also warned that supply capacity in the economy may be lower than previously estimated, particularly due to labour shortages and elevated business costs.
Indicators such as business surveys and labour costs suggest capacity constraints intensified alongside rising inflation, raising uncertainty about how quickly price growth will moderate.
Despite the expectation inflation will ease, the bank acknowledged ongoing risks, including global economic uncertainty and the possibility inflationary pressures may persist longer than forecast.
Central bank monitoring closely
The Reserve Bank said it will continue closely monitoring economic data, including Australia’s new monthly inflation measure, to refine its forecasts and policy response.
While inflation is projected to decline over time, Tuesday’s speech signals policymakers remain cautious, reinforcing expectations that interest rates will play a critical role in restoring price stability.
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