Australia’s monetary policy took a sharp and unexpected turn as the Reserve Bank of Australia lifted its benchmark cash rate by 25 basis points to 3.85%, ending a brief easing cycle that delivered three rate cuts last year. The decision underscores how quickly inflation dynamics have shifted, forcing policymakers to prioritize price stability even as households remain sensitive to borrowing costs.

The move follows fresh government data showing consumer price inflation accelerated to 3.8% year-on-year in December, up from 3.4% the previous month and well above the RBA’s 2%–3% target range. After inflation appeared to be firmly cooling earlier in 2025, the renewed surge has reignited concerns that price pressures are proving more persistent than policymakers anticipated.

Inflation Resurgence Forces Policy Reversal

In its statement, the RBA said inflation had “picked up materially” in the second half of 2025, warning that price growth is likely to remain above target for some time. While inflation is far below its 7.8% peak in late 2022, the recent rebound has raised doubts over whether last year’s rate cuts were premature.

The central bank also highlighted the surprising resilience of economic activity. Despite global uncertainty, Australia’s major trading partners have delivered stronger-than-expected growth, supporting exports and domestic income. That external strength, combined with firm household spending and investment, has kept demand elevated — complicating the inflation fight.

A Hotter Economy Than Expected

Labour market data has added to the RBA’s unease. The unemployment rate fell to 4.1% in December from 4.3% a month earlier, signalling continued tightness in jobs markets. Such conditions tend to reinforce wage pressures and consumer demand, making it harder for inflation to drift lower on its own.

EY Oceania chief economist Cherelle Murphy described the rate hike as unusual so soon after easing, noting that inflation trends looked benign at the time of the last cut. With hindsight, however, the economy now appears to have been running hotter than expected, increasing the risk that policy was left too loose.

Political and Household Implications

The decision has immediate consequences for mortgage holders and businesses. Treasurer Jim Chalmers called the hike “difficult news” for millions of Australians, while pushing back against criticism that government spending is the main inflation driver. The RBA instead pointed to private demand — particularly household consumption and investment — as the dominant force behind renewed price pressures.

This distinction matters politically, as cost-of-living pressures remain a central issue for voters, and any perception of policy missteps could carry broader economic and electoral consequences.

What Comes Next for Rates?

The RBA stopped short of signalling a sustained tightening cycle, but its language suggests policymakers are now firmly data-dependent. If inflation fails to moderate and labour markets remain tight, further rate increases later in the year cannot be ruled out. For investors and households alike, the episode serves as a reminder that the path back to price stability may be neither smooth nor predictable.