Steve Campbell: Inflation concerns rising, rate hike on the table

Rates are on hold, but the market is pricing in a 30 per cent chance of a hike in the March quarter. Pendal’s head of cash strategies STEVE CAMPBELL explains what’s changed

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THE Reserve Bank left the cash rate unchanged at 3.6% at its December meeting.

No change was expected.

At today’s meeting the RBA acknowledged that inflation had picked up recently – though some of the increase was due to temporary factors.

A new monthly inflation series from the Bureau of Statistics (more on that later) won’t be relied upon by the RBA for a while, but some components are showing a more persistent rise.

A year ago a noticeably dovish twist in the RBA’s December 2025 meeting set up market expectations for a February 2026 rate cut – which was ultimately delivered.

Today a hawkish twist was expected based on the RBA’s November meeting. On Cup Day two options were discussed for nearer-term monetary policy decisions: no change or a rate cut.

At that point, rate hikes didn’t come into it.

The case for a cut was based on a materially weaker labour market or a pull-back in spending and dampened growth due to increased household caution.

If either had eventuated, the potential increase in excess capacity may have warranted further easing.

A change in market pricing

So what’s happened since Cup Day?

Market pricing has moved significantly. Rate cut expectations are gone, replaced by potential hikes.

A rate hike in the March quarter is priced around a 30% chance. The following graph shows market pricing for the RBA cash rate following the November meeting and pricing leading into this week’s meeting:

What was the catalyst for change?

It wasn’t the stronger labour market data which saw unemployment fall to 4.3%.

It wasn’t the better household consumption spending in the quarterly accounts released in early December.

It was the new monthly inflation data released in late November, which saw yields move sharply higher.

The data showed annual trimmed mean of 3.3%. That is outside the RBA’s 2-3% target band and is moving in the wrong direction!

What is the new monthly inflation series and why does it have this impact?

The new ABS series covers the monthly move for 87% of the inflation basket.

The remaining 13% have one-off annual changes for items such as school fees, council rates and health insurance premiums.

There will be some volatility in this new series. It will take time to bed down seasonal adjustments before the RBA uses it to determine if changes to the cash rate are required.

For now, the quarterly inflation series remains the key inflation data input into decision making.

The new monthly data caused some concern but it will be more volatile in its infancy.

To hike or not to hike?

The RBA would be one of the few outliers among most central banks if it was to hike early next year.

Or, indeed, if it hiked at all in 2026.

The other outlier is the Bank of Japan, which is expected to tighten policy at its meeting on December 19.

Other central banks are expected to ease further or remain on hold for most of 2026.

In the United States, the Federal Reserve is priced for around three cuts by the end of 2026.

The Bank of England has two cuts for the same period.

If market pricing was to eventuate it would leave Australia with the highest policy rate among developed market economies by the end of next year.

As you can see, while we’ve had the highest rates at various points we also have tended to move in the same direction as other central banks.

What’s driving the change?

The issue this time – particularly relative to the US – comes down to labour market slack.

Both countries are above their inflation targets.

In the US, expected weakness in the labour market is seen as exerting downward pressure on inflation, providing scope for the Fed to remove some policy tightness.

In Australia, inflation momentum is going the other way at a time of high uncertainty in the labour market.

The RBA looks at the unemployment rate as well as a host of other indicators when assessing the labour market – job ads, vacancies, business liaison.

The labour market has been assessed as remaining slightly tight.

The NAB’s business survey also shows capacity utilisation remaining at elevated levels.

The RBA’s deputy governor Andrew Hauser commented on this in a speech in November, observing that this time around we may not have much excess capacity in the economy.

If economic growth picks up with no improvement in productivity, then inflation outcomes will be less than desirable.

That means rate hikes are coming.

What’s next

What are the key data releases that will determine what’s next for the RBA?

The ABS’s next monthly inflation series is released on January 7, but the fourth-quarter inflation data released on January 28 will be the major factor.

The RBA doesn’t want to swim against the tide. One more upside inflation surprise means the RBA may be close to hiking in the first half of next year.

If you’d like to hear more about how Pendal’s Income & Fixed Interest team is positioning for this environment, please contact us through your account manager by reply email.

About Steve Campbell and Pendal’s Income and Fixed Interest team

Steve Campbell is Pendal’s head of cash strategies. With a background in cash and dealing, Steve brings more than 20 years of financial markets experience to our institutional managed cash portfolio.

Find out more about  Pendal’s cash funds:

Short Term Income Securities Fund
Pendal Stable Cash Plus Fund

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

Find out more about Pendal’s fixed interest strategies here