Australia's Inflation Expectations: The 4.6% Print vs. the Market's Priced-In Relief

The market was looking for relief. After a period of easing, the whisper number for Australian inflation expectations was trending lower, suggesting the worst of the price pressure might be over. The reality, however, is that persistent underlying forces are keeping expectations elevated, creating a clear gap between priced-in optimism and the data.

The latest survey from the Melbourne Institute shows expectations for consumer inflation in December 2025 climbed to 4.7% from November's four-month low of 4.5%. This rise is the critical data point. It means expectations are not cooling as hoped; they are ticking higher even as the Reserve Bank of Australia (RBA) held its cash rate steady at 3.6% for a fourth consecutive meeting. The market had priced in a cooldown, but the data shows sticky pressures are not being anchored by current policy.

This expectation level is significantly above the RBA's target band. At 4.7%, it sits well outside the central bank's 2-3% range. More telling is the comparison to the recent past. The December figure is only slightly below the 4.6% level seen in January 2025, indicating expectations have been stuck in a high range for over a year. The brief dip in November was an outlier, not a trend reversal.

The bottom line is that the expectation gap is widening. The market narrative of a clear inflation cooldown is not being met by the survey data. Persistent price pressures, as noted by Governor Michele Bullock, are keeping households' forward-looking views elevated. This creates a tangible risk to the "higher for longer" rate outlook, as it suggests the disinflation process is slower and more fragile than anticipated.

Market Reaction and Priced-In Implications

The market's reaction to sticky inflation expectations is a classic case of "sell the news" after a period of relief. The data showing expectations ticking back up to 4.7% is a clear miss against the whisper number of a cooldown. This reality check challenges the priced-in optimism that the disinflation process was gaining traction.

The core implication is for the Reserve Bank's rate path. The market had been pricing in a "higher for longer" scenario, but persistent expectations suggest that monetary policy may need to stay restrictive even longer to anchor inflation. The Governor's comments about Q3 inflation being "slightly stronger than anticipated" and the "persistence in certain categories" align with this data, indicating that the easing cycle may be paused for longer than expected.

This pressure is also visible in the underlying inflation data. The RBA's preferred core measure, the trimmed-mean CPI, eased to 2.7% in Q3. While that's a step down from its peak, it remains above the midpoint of the 2-3% target band. More critically, the Melbourne Institute Monthly Inflation Gauge has been at or above the top of the RBA's target band for three consecutive months. This persistent pressure at the monthly level signals that core inflation is not fully subdued, providing a rationale for the central bank to hold its ground.

The bottom line is that the expectation gap is translating into a policy gap. The market's narrative of a clear disinflation trend is being undercut by data showing sticky pressures. This creates a risk that the "higher for longer" rate pricing is too optimistic, as the central bank may need to wait longer for evidence that expectations are truly anchored before considering a cut.

Forward Implications: Guidance Reset or Further Divergence?

The expectation gap is now a forward-looking bet. The next few data points and policy moves will determine if the market's priced-in "higher for longer" narrative holds or if expectations continue to diverge further from the RBA's target.

The immediate test is the February 2026 inflation release. This report will show whether the January expectation of 4.6% is being validated by the underlying data or if pressures are building. A print that confirms expectations are holding steady or rising would cement the view that disinflation is fragile. A surprise drop, however, could start to reset the trajectory and signal that the central bank's policy is finally taking hold.

The RBA's next policy meeting in February will be critical. Any dovish shift in guidance-hinting at a faster pace of cuts or a lower terminal rate-could act as a powerful reset for expectations. But a hawkish stance, emphasizing the need to wait for more evidence of anchored inflation, would likely widen the gap. The central bank's caution about inflation being "more persistent than anticipated" provides a clear rationale for such a stance, especially if the February inflation data shows resilience.

External risks add another layer of uncertainty. Global commodity flows and geopolitical tensions, particularly between the U.S. and China, could feed into imported inflation and sustain expectations above the target band. These are forces the RBA cannot control, but they can influence the domestic price-setting environment and complicate the central bank's task of anchoring expectations.

The bottom line is that the setup favors continued volatility. The market is looking for a guidance reset to justify its pricing, but the data and the central bank's caution suggest a longer wait. Until expectations converge with the target band, the "higher for longer" narrative will remain a fragile bet.