Key points:
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- I give the RBA 4 crosses out of 4 for inflation control.
- More than a year ago (before the RBA rate cuts), I wrote that it had no reason to cut (aside from political pressure). Rates were already too low (inflationary), so when it cut rates, inflation rose as expected.
- The RBA now has to correct its mistake (again!)
- The problem was that the RBA raised cash rates later, slower, and lower than the rest of the world in 2022-3, leaving inflation stickier here. Plus we have our unique centralised wage fixing system, cozy monopoly / oligopoly structures in most domestic industries, and governments running inflationary deficit spending sprees.
- What it means for portfolios – and how I positioned for this.
- Will the RBA hike rates next week? Will that be the end of it?
Regular readers of my monthly reports would know that I have been saying for the past two years that the RBA had no fundamental reason to cut rates as it did in 2025 (aside from political pressure).
Aside from my regular monthly reports, here’s my December 2024 story on real interest rates, warning about rates being too low and inflationary-
But the RBA cut rates anyway, and now has to reverse course.
Here’s my updated chart of Australian inflation, unemployment, and interest rates – nominal and real. The key events in the past couple of weeks have been higher than expected inflation and stronger than expected jobs numbers.
I give the RBA 4 crosses out of 4 for inflation control.
Inflation in Australias remains problematic, but for different reasons than the US. The RBA has only three rate cuts in this cycle (Feb, May, August 2025), while most other countries have made several more cuts as inflation has edged down. (For example, there have been 8 rate cuts in Europe, 9 in Canada, 9 in NZ, 6 in UK, 6 in the US).
The problem was that the RBA raised cash rates later, slower, and lower than the rest of the world in 2022-3, leaving inflation stickier here. Plus we have our unique centralised wage fixing system, cozy monopoly / oligopoly structures in most domestic industries, which means companies can just pass on price increases to customers, with little competitive pressure on margins and profits.
On top of that we have federal and state governments continuing to run inflationary deficit spending sprees with no sign of fiscal responsibility.
Here are my four key measures:
1.. Annual Inflation rate too high
The rolling 12-month annual CPI inflation rate (black line in upper section of the chart) is back up to 3.8%. It has run back up to well above the RBA’s target 2-3% range since the RBA started cutting rates in 2025.
Nothing ‘unexpected’ about that!
2.. Current running rate too high
Although the 12-month rate is the most quoted inflation number in the media, it often says more about what inflation was 12 months ago than the current ‘running rate’ or current trend, which is more important. Therefore I annualise the most recent 3-month rate as a better measure of the current inflation trend and direction (orange line in upper section).
However, one disadvantage of this annualised 3-month running rate is that it is more volatile than the 12-month rate as it contains a lot of temporary effects, like the power subsidies coming in and out of the equation.
The annualised 3-month ‘running rate’ to December is now back up to 3.9% - far too high. The main problem areas are housing rents, electricity, gas, healthcare, tobacco, and education costs.
Also, the RBA’s preferred ‘trimmed mean’ inflation measure is back up to 3.4% - which is also far too high, and on still on the rise (up from 3.0% in September).
3.. Unemployment too low
Unemployment in Australia had been rising slowly but steadily from a low of 3.4% in late 2022, up to 4.5% in September 2025. However it is now back down to 4.1%, thanks to strong jobs growth – especially in government and other ‘non-market’ sectors.
The current unemployment rate is back below the level RBA regards as a ‘neutral’ rate – ie jobs growth is back to inflationary levels (RBA’s non-accelerating inflation rate of unemployment (‘NAIRU’) is around 4.5%. Below that level puts pressure on wages and prices).
‘Participation rates’ (the number of people in the workforce as a percentage of working age population) are still near record highs, due almost entirely due to expansionary government-related hiring. The government sector has been expanding, but the real economy is doing it tough as consumers tighten their belts.
As in the case of the US, the most obvious motivation for a further series of rate cuts would be a local recession, which would lift unemployment and probably soften inflation pressures, allowing (or necessitating) rate cuts.
4.. Real Cash Rates too high
The lower section of the chart shows the ‘real cash rate’ – ie the current cash rate (ie the ‘risk-free’ rate) minus CPI inflation.
There is much debate among central bankers as to what is the ideal ‘real risk-free rate’ (ie real cash rate), which enables an economy to run at ‘full employment’ while keeping inflation in check. This ideal ‘natural’ or ‘neutral’ real interest rate (also known as ‘r-star’ or r*) is by far the most common topic of debate in my discussions with former central banking friends and colleagues.
There are many factors that affect the ideal average ‘natural’ real interest rate (including productivity, demographics, banking/credit regulation/policy, exchange rates, etc), but the general principle is that in a growing economy the real risk-free rate should be roughly similar to the expected average real rate of growth in the overall economy.
My chart shows actual (ie historical) inflation and cash rates over time, but central bankers must set cash rates based on expectations of future conditions, which is little better than a wild guess.
‘Natural’ real interest rate for Australia
If we were to assume future average real economic growth at say 2% for Australia (being a modest 1.5% population growth plus say 0.5% productivity growth), then the average real cash rate should also be around this 2% level. Therefore, if we assume future inflation at say 2.5% pa (middle of RBA’s target 2-3% range) then nominal cash rates should average around 2% real rates + 2.5% inflation = around 4.5% or thereabouts.
This would be a central average rate through cycles, running higher in economic booms (to curb rising inflation in booms), and lower in busts (to stimulate borrowing, spending and hiring).
This average nominal cash rate of around 4.5% is precisely what it was in Australia in the three decades prior to Covid. The problem is that most people have forgotten that, and have now become accustomed to near-zero interest rates. Those days are well and truly gone.
In Australia, the actual real risk-free rate has averaged around 0.5% to 1% lower than real GDP growth rates in recent decades. For example - since 1980 real GDP growth has averaged 3.1% pa, but real cash rates have averaged 2.5%.
That difference was largely made possible by the productivity gains from the late 1980s to early 2000s, but they have now disappeared. Governments and political parties on all sides have abandoned any thought of serious productivity-boosting reforms and quaint notions of ‘fiscal responsibility’, and instead just throw ‘free’ money at the clamouring populace to buy votes. Let future tax-payers worry about the consequences, after we are long gone!
Whether the ideal ‘natural’ real risk-free cash rate should be around the same level of real GDP growth, or perhaps a half a percent or so below that, it is clear that it is far too low (ie too inflationary) at current levels.
Real cash rates were too low before the RBA’s rate cuts in 2025, as I wrote in December 2024. The rate cuts were bound to be inflationary, especially as the RBA knew, and tried to warn the government, of inflationary, out of control deficit spending at federal and state levels.
Will RBA raise rates next week? It certainly should. If it doesn’t hike rates it will lose whatever shred of credibility it has left.
Will that be the end of rate hikes? Probably not.
Where the rubber hits the road
Readers would know that everything I write is original, fact-based, non-conflicted research for the purposes of use in my own portfolios and in client portfolios in firms I advise. It is not just idle chatter or noise I do for fun. My own money (and in advice firm client portfolios I advise) is on the line.
In my published ETF portfolio (with my own money) readers would know that I have been out of fixed rate bonds since 2021 (fearing sticky inflation and rising bond yields), and in gold (inflation fears + ‘debasement’). Double bonus for me!
‘Till next time. . . . safe investing, and stay healthy!
Further reading –
My 2024 story warning about rates being too low and inflationary-
For my assessment of the impact of wages on inflation -
For my 2025 year-end wrap-up of local & global markets for Aussie investors:
For asset class returns for the past 35 years including 2025, see –
For an update on my current BIG challenge -