In the lead-up to the Reserve Bank of Australia's (RBA) February meeting, a familiar chorus has emerged from financial circles: raise interest rates. Many economists and investors are clamouring for action, betting on a hike as a near-certainty. Yet, a deeper dive into the data reveals why such a move might be premature and misguided.
The Market's Obsession with Rate Movements
There is a pervasive fixation in Australia's economic discourse that interest rates must constantly do something—whether up or down. This mindset treats every monthly statistic as a call to arms. When unemployment fell recently, some argued rates needed to respond, as if fewer jobless people were a problem to be solved. Similarly, a single-month uptick in inflation has sparked panic, with demands for immediate rate hikes.
This sentiment is echoed by investors, or more accurately, speculators, who have been wagering on a rate increase. Before the December Consumer Price Index (CPI) figures were even released, markets priced in a 58% chance of a rise on 3 February. After the data showed inflation climbing from 3.4% in November to 3.8% in December, those odds jumped to roughly two in three.
Why the Australian Dollar Reacted
The anticipation of higher rates led to a slight bump in the Australian dollar. International investors, seeking to capitalise on potential returns from Australian bonds and financial instruments, increased demand for the currency, pushing up its exchange rate. This reaction was further fuelled by December's unemployment figures, which saw a significant drop to 4.1%, reinforcing bets on imminent rate action.
Decoding the Inflation Numbers
At first glance, the December inflation figure of 3.8%—with a monthly jump of 1%—seems alarming. However, a closer examination tells a different story. The surge was overwhelmingly driven by specific, volatile components.
International holidays and travel accounted for a staggering 71% of all inflation in December, while domestic holidays contributed another 26%. When these holiday-related costs are stripped out, inflation in December rose by a mere 0.02%, and the annual growth rate would have remained steady.
The Role of Electricity Prices
Over the past year, electricity has been another major driver of inflation, accounting for about 10% of the increase. Yet, this spike is largely artificial. In Brisbane, electricity prices in December 2025 were 456% higher than a year earlier, primarily due to the removal of state energy subsidies that were in place in December 2024. Perth saw a similar trend, with a 75% rise attributed to subsidy changes.
Excluding these erratic items—holidays and electricity—annual inflation actually peaked at 3.1% in October and stabilised at 3.0% in both November and December. This highlights the danger of fixating on headline numbers without scrutinising the underlying causes.
The RBA's Broader Data Considerations
The Reserve Bank will also review quarterly figures, which showed a modest 0.6% rise in CPI for the December quarter, with underlying inflation (trimmed mean) increasing by 0.9%. Annual figures for both metrics rose, but again, this was influenced by electricity subsidies included in older data but absent in the latest releases.
Economic Context: Wages and Employment
Despite unemployment dipping below 4.5%, there is no evidence of wages taking off. Recent job vacancy figures indicate that finding work is becoming more difficult, not easier, suggesting that wage growth will continue to slow. This context is crucial for the RBA, as rate hikes could further dampen economic activity without addressing the root causes of inflation.
The Path Forward for the RBA
The easy option for the RBA next week is to raise interest rates. Many in the financial sector would applaud such a move, and criticism would be minimal since it aligns with market expectations. However, this approach risks overlooking the nuanced reality of the data.
The smarter strategy is to exercise patience. By looking beyond the volatile components of inflation and considering the broader economic indicators, the RBA can avoid a knee-jerk reaction that may do more harm than good. Waiting allows for a clearer assessment of whether inflationary pressures are persistent or merely temporary blips.
In summary, while market forces push for a rate hike, the Reserve Bank of Australia faces a critical decision. Opting for a cautious wait-and-see approach could prove far more prudent in the long run, ensuring monetary policy responds to genuine economic trends rather than speculative fervour.
