Australia’s central bank raised interest rates on Tuesday, reversing its recent easing stance as it grapples with inflation in a supply-constrained economy. The move has led markets to anticipate further hikes later this year.
The Reserve Bank of Australia (RBA) now joins the Bank of Japan as one of the few developed-world central banks actively tightening policy. By contrast, markets still expect rate cuts in the U.S., UK, and Canada, while the European Central Bank is widely projected to maintain an extended pause.
At its February policy meeting, the RBA unanimously increased the cash rate by 25 basis points to 3.85%, marking the first hike in two years, just six months after its last cut in August. The bank noted that it remains uncertain whether financial conditions are sufficiently restrictive.
RBA Governor Michele Bullock declined to comment on the likelihood of further increases, despite new economic forecasts assuming additional tightening to bring inflation back within the 2–3% target band.
“I don’t know if it’s in a tightening cycle. Certainly it is an adjustment, and the board is actively monitoring the data,” Bullock said. “We believe financial conditions are roughly neutral at this stage.”
Markets had priced in a 78% probability of a rate hike following higher-than-expected fourth-quarter inflation and a seven-month low in unemployment in December. The RBA noted that while some inflationary pressures are temporary, private demand is growing faster than anticipated, capacity constraints are significant, and labor markets are tight.
“The board judged that inflation is likely to remain above target for some time, making it appropriate to raise the cash rate,” the RBA said in its policy statement.
The Australian dollar extended gains to $0.7002, up 0.9%, while three-year government bond yields jumped 8 basis points to 4.3%. Investors now see a 75% probability of a follow-up hike in May, with a total expected tightening of 40 basis points this year.
Outlook for Further Hikes
Unlike some international peers, the RBA had previously avoided aggressive rate increases to preserve labor market gains. However, the three rate cuts last year allowed inflation to resurface, prompting the bank to pivot toward a hawkish stance in late 2025.
Consumer price growth has exceeded expectations for two consecutive quarters, remaining above the 2–3% target. Core inflation—the RBA’s preferred measure—rose 0.9% in the fourth quarter, pushing the annual pace to 3.4%, the highest in over a year. The RBA now projects inflation will peak at 3.7% by June, before falling to 2.6% by mid-2028, slightly above the target midpoint of 2.5%.
Recent data also highlight a tightening labor market, with unemployment unexpectedly falling to 4.1%. Strong consumer spending, record-high housing prices, and easy credit conditions suggest that financial conditions may not be restrictive.
Sally Auld, Chief Economist at National Australia Bank, said the RBA’s move is unlikely to be a one-off.
“We continue to forecast a follow-up 25bp hike in May, though risks point to an earlier increase or a more substantial 50bp adjustment,” she said.