Will RBA hike the cash rate next week?

The headline inflation rate rose 3.8% through 2025 and, at 3.35%, annual underlying inflation is also well above the RBA's 2-3% target range.

With unemployment back down at 4.1% in November - possibly around or even below the Non-Accelerating Inflation Rate of Unemployment (NAIRU) - many economists now feel the data suggests demand is once again running ahead of what the Australian economy can supply.

Economists from all four major banks are officially predicting the RBA will deem another 25 bps hike necessary to ease this pressure, taking the cash rate back to 3.85%

Westpac chief economist Luci Ellis (former assistant RBA Governor) officially changed her view after the December price data, which she said is likely to be the "casting vote".

"When the economy is close to full employment and full capacity utilisation, it is hard to know which side of the line it is on," Ms Ellis said.

"Inflation outcomes are the best guide in this situation ... with trimmed mean as the clearest sign of the underlying inflation trend, its quarterly result in the December quarter implies the RBA is likely to raise rates at the February meeting."

The RBA ASX rate tracker, which estimates monetary policy outcomes based on cash rate futures speculators, puts the probability of a 25bps hike at 67% as of 29 January.

Economy at capacity?

For the mortgage holders that have successfully managed the high rate period by curbing their own spending, the news that inflation has reared its head once again may have been a nasty surprise.

Now that pandemic-related supply chain issues are mostly resolved, many were expecting the economy would be able to absorb the extra demand.

But economists say the data suggests that the economy is at capacity, which means it's close to using all the available labour and other capital resources - so any increases in demand result in inflation.

Paul Bloxham, chief economist at HSBC, says the "key story" in why prices keep going up is that labour productivity growth (how much the economy can produce for a given amount of labour and capital) has been weak or even negative, hurting how fast the economy can grow sustainably.

"Productivity growth has been dismal, and this has constrained the supply-side of the economy," Mr Bloxham explained.

He says if the RBA does hike next week, it's a "clear signal" the economy is already growing too quick, even with annual GDP growth at just 2.1% through the twelve months to September.

"The rate hike ... will of course not actually fix the primary problem - which is that the supply side and productivity are weak," he said.

Is a hold still a possibility?

Part of what ramped up the initial speculation about rate hikes in 2026 was what many called a hawkish rhetoric tilt from RBA governor Michele Bullock after the December decision.

While she told media it appeared the upside inflation surprise was at least partly because of "temporary factors" in November, in December she acknowledged the possibility that inflationary pressures would be persistent.

"It's very uncertain what is temporary and what is persistent," she said.

December was also the first press conference in which she seemed to rule out rate cuts for the time being, given the "underlying momentum in the economy".

She also outlined what the RBA board will be looking at when determining whether more hikes are needed.

"What we're looking for in underlying inflation is some sort of clues to whether or not that large increase in quarterly trimmed mean inflation in the September quarter ... was demonstrating that there is underlying capacity pressures in the economy," she said.

"Some of the things giving us pause ... there's market services, there's new dwellings, there's durable goods."

Trimmed mean inflation rose 0.9% through the December quarter which, while less than in the September quarter (1%), was still otherwise the highest since March 2024 - the first full quarter after the cash rate was hiked to 4.35%.

However, it's still well below the quarterly rate throughout 2022 and early 2023, when the cash rate was last being hiked.

Rates rose from 3.60% to 3.85% in May 2023.

Given Ms Bullock has said she's "very conscious" of how rate hikes impact mortgage holders in the past, there may still be an outside chance the board votes to wait and see how prices develop in the first quarter of 2026.