Assessing the RBA's Dilemma: Will Australia's Sticky Core Inflation Force a Rate Hike in 2026?

The Reserve Bank of Australia (RBA) faces a delicate balancing act in 2026 as it navigates the tension between cooling persistent inflation and safeguarding economic growth. While headline inflation has eased slightly in recent months, core inflation remains stubbornly above the RBA's 2–3% target range, raising questions about whether the central bank will resume tightening monetary policy. This analysis examines the drivers of inflation persistence, the RBA's evolving policy stance, and the likelihood of a rate hike in 2026.

Sticky Core Inflation: A Persistent Challenge

Australia's annual inflation slowed to 3.4% in November 2025, down from 3.8% in October, driven by falling electricity prices as government rebates expired. However, core inflation metrics, such as the RBA's trimmed mean inflation, remain elevated at 3.2% annually. This stickiness is fueled by persistent demand-side pressures, particularly in housing costs, which rose by 1.1% in November due to surging rents and new dwelling prices. Meanwhile, monthly CPI data showed no change in November, with declines in categories like clothing and recreation offsetting gains in services.

The broader concern lies in inflation expectations. The ANZ-Roy Morgan Inflation Expectations index hit a two-year high of 5.6% in early December 2025, driven by rising energy prices, including petrol retail prices averaging $1.83 per litre. Such expectations risk embedding inflation into wage and price-setting behavior, complicating the RBA's mandate to return inflation to target.

RBA Policy Outlook: A "Meeting-by-Meeting" Approach

The RBA's November 2025 Statement on Monetary Policy acknowledged that inflation will likely remain above target until the second half of 2026, with year-ended headline inflation projected to be slightly above the midpoint of the target range by late 2027. While the central bank has cut rates three times in 2025, it has warned that further tightening could be necessary if inflation proves more persistent than anticipated.

Market pricing reflects this uncertainty. Cash rate futures indicate a 93% probability of a rate hike by June 2026, with a fully priced-in 0.25 percentage point increase by August. However, economists remain divided. CBA analysts predict a 0.25% hike in February 2026, pushing the cash rate to 3.85% by year-end, while Westpac economists argue the RBA is more likely to hold rates at 3.6% for the entirety of 2026. The RBA itself has emphasized a "meeting-by-meeting" approach, underscoring its reliance on incoming data to guide decisions.

Drivers of Inflation Persistence: Beyond Transitory Factors

The RBA has identified several structural factors contributing to inflation's stickiness. First, a persistent supply-demand imbalance persists, with robust consumer demand outpacing weak productivity growth. Over 50% of inflation components recorded increases above 3% in Q3 2025, signaling a broad-based inflationary environment. Second, labor market tightness remains a concern. Although the unemployment rate rose slightly to 4.3% in June 2025, the job vacancy-to-unemployed ratio remains elevated, suggesting residual pressure on wages.

Governor Michele Bullock has highlighted that while some inflationary pressures are temporary-such as the expiration of electricity rebates- others, like services inflation and wage growth, appear more entrenched. If Q4 trimmed mean inflation exceeds 0.8% quarter-on-quarter, it would significantly raise the risk of a 2026 rate hike.

Global Context and Economic Growth: A Delicate Tightrope

Australia's inflation trajectory places the RBA as an outlier in the global easing cycle. While central banks like the Federal Reserve and the Bank of England have signaled rate cuts in 2026, the RBA's terminal rate is expected to remain among the highest in developed markets. This divergence has supported the Australian dollar but also exposed the economy to external risks, including global trade tensions and energy price volatility.

Economic growth is projected to remain modest, at 1.8% in 2025 and 2.1% in 2026, driven by a recovering private sector and a still-tight labor market. However, the RBA must weigh the risks of tightening too soon-potentially stifling growth-against the costs of allowing inflation to become entrenched.

Conclusion: A Data-Dependent Path Forward

The RBA's 2026 policy path hinges on two critical factors: the persistence of core inflation and the evolution of inflation expectations. While headline inflation has shown some moderation, the stickiness in housing costs, services, and wage growth suggests that the RBA cannot afford complacency. A rate hike in early 2026 appears increasingly likely if incoming data confirms that inflation is not cooling as rapidly as projected.

For investors, the key takeaway is the RBA's commitment to a data-dependent approach. Assets sensitive to rate hikes-such as commercial real estate and high-yield bonds-may face volatility if tightening resumes. Conversely, sectors insulated from monetary policy, like infrastructure and utilities, could benefit from the RBA's focus on maintaining economic stability. As the central bank navigates this dilemma, vigilance in monitoring inflation indicators and labor market trends will remain paramount.