Australia is approaching another interest rate decision with an uncomfortable combination of stubborn inflation, rising oil prices, weakening household purchasing power and a global bond sell-off that is already lifting borrowing costs before the Reserve Bank acts.
The RBA has raised the cash rate by 75 basis points this year to 4.35 per cent. Financial markets now assign about a 72 per cent probability to a further quarter-point increase, which would take it to 4.60 per cent when the Monetary Policy Board meets on September 28 and 29. ASX interest-rate futures suggest a rise is probable, although not yet certain.
The argument for another increase is straightforward. Annual inflation was 3.5 per cent in July, while the trimmed mean measure watched closely by the RBA remained at 3.6 per cent. Both are above the bank’s 2 to 3 per cent target. Automotive fuel prices jumped 7.5 per cent during July as world oil prices rose and the federal government began partially unwinding its fuel excise relief. ABS figures also show housing costs rising by 5 per cent over the year, including increases in new dwellings, rents and electricity.
The RBA warned after its August meeting that inflation remained too high, underlying inflation had changed little and oil and related commodity prices were still above their levels before the Middle East conflict. It left the cash rate unchanged then, but its language left open the possibility of further tightening if inflation failed to ease. The bank has acknowledgedthat financial conditions are already restrictive and are slowing the economy.
Economist Stephen Koukoulas believes an increase is now close to inevitable. “The inflation data and global developments make that rather obvious,” he said, arguing that the RBA had said enough publicly to leave little doubt about its immediate direction.
Australia’s economy is not in recession and its aggregate figures are not disastrous. But the comfort offered by 2.1 per cent growth looks different from the household kitchen table, where wages have again fallen behind prices and another mortgage increase may be approaching
Beyond September, however, he sees a less certain path. Business conditions, house prices, consumer sentiment and government demand are all showing signs of fatigue, he said, pointing towards weaker growth through the remainder of 2026 and into 2027.
One more increase may be justified by present inflation, but each rise works with a delay. The RBA risks tightening against yesterday’s data just as households and businesses begin responding to the increases already delivered.
Australia’s economy grew by 0.4 per cent in the June quarter and 2.1 per cent over the year. Koukoulas describes that as “a pretty good story”, arguing that faster growth would risk adding to inflation. The national accounts were less emphatic, describing growth as modest and concentrated in pockets of private demand, mining exports and inventory movements. The ABS said some of the stronger private demand was met through higher imports rather than domestic production.
Household spending rose 1.1 per cent in July and 7 per cent over the year in current prices, including a 1 per cent increase in discretionary spending. That supports Koukoulas’ view that activity has not collapsed. But nominal spending is not the same as improving living standards. Households may be spending more because food, housing, energy and services cost more, not because they are consuming substantially more.
That is where Ross Gittins’ argument enters the picture. Gittins in today’s The Age argued how Australia’s cost-of-living crisis is at heart a wages crisis. Prices surged after the pandemic while workers failed to secure matching increases, leaving the purchasing power of wages about 5 per cent lower by March 2023. Subsequent wage increases have largely kept pace with inflation but have not repaired the earlier loss.
Household spending is rising, but that does not necessarily mean living standards are improving. As Ross Gittins argues, Australians are spending more while carrying a lasting real-wage loss, with purchasing power still about 5 per cent below its pre-inflation position
The latest figures strengthen that concern. Wages grew by 3.2 per cent over the year to June, including 3.1 per cent in the private sector. Inflation was running at 3.5 per cent by July. ABS wage data therefore suggest real wages are again slipping backwards.
Gittins argues that the economy is weak because workers lack sufficient bargaining power to recover what inflation took from them. He also challenges the conventional claim that productivity must improve before wages can rise. His view is that higher labour costs give employers a reason to invest in machinery, technology and better processes, while cheap labour reduces that incentive.
There is an apparent conflict between Gittins and Koukoulas. One sees inadequate wages and weak household purchasing power. The other sees an economy growing near the speed it can sustain without producing more inflation.
Both conditions can exist at once. Australia may be close to its present supply capacity while households remain worse off. If housing, energy, transport and other essential systems cannot expand efficiently, demand can run into supply constraints even without households feeling prosperous. Interest rates then suppress spending without repairing the productive weaknesses that caused prices to rise.
Oil makes that problem harder. Koukoulas opposes another cut to fuel excise, saying higher petrol prices act like a rate rise by reducing the money households can spend elsewhere. Leaving the excise unchanged, he argues, would protect improving federal finances while accelerating the shift towards electric vehicles and renewable energy.
Economically, the argument has force. Politically, it is difficult. A petrol shock is a blunt form of demand restraint. It falls heavily on outer-suburban, regional and lower-income households that cannot easily change vehicles, work from home or avoid driving. The RBA’s interest-rate increases are also uneven, bearing most directly on recent homebuyers and indebted businesses.
The result is a policy system relying on particular groups to absorb much of the adjustment.
Global bond markets are adding another layer of pressure. Australia’s 10-year government bond yield reached about 5.4 per cent this week, its highest level in roughly 15 years and more than a percentage point above its level a year earlier. Market data put the yield at about 5.38 per cent on September 16.
This matters beyond professional bond traders. Long-term yields influence fixed mortgage rates, business borrowing, infrastructure finance and the government’s future interest bill. They also raise the return investors can earn from relatively safe assets, placing pressure on share and property valuations.
Similar movements are occurring overseas. The US 10-year Treasury yield has crossed 5 per cent, while Britain’s 30-year borrowing cost has approached 6 per cent. The Kobeissi Letter described the British bond market as “collapsing”, citing renewed energy inflation, deteriorating public finances and the possibility of further Bank of England tightening.
US macro strategist Vincent Deluard sees stagflation as the most likely outcome for the American economy. He argues that wage increases have been unexpectedly moderate despite tight employment
“Collapsing” is an overstatement unless market liquidity or government financing itself begins to fail. But the rise in yields is real. Investors are demanding greater compensation for inflation, expanding public debt and the risk that central banks will keep rates higher for longer.
US macro strategist Vincent Deluard sees stagflation as the most likely outcome for the American economy. He argues that wage increases have been unexpectedly moderate despite tight employment, possibly because workers fear displacement by artificial intelligence. His preferred explanation, however, is that wages are merely responding slowly.
Once households exhaust their remaining pandemic savings and confront higher bills, Deluard expects workers to seek larger increases. That would be reasonable from the worker’s perspective but could prolong inflation while economic growth weakens.
It is the American version of the problem identified by Gittins in Australia. Workers have absorbed a real-income loss. Recovering it may support demand and living standards, but central banks may interpret stronger wages as another inflation risk.
Wall Street strategist Tom Lee remains bullish despite expecting US Federal Reserve chair Kevin Warsh to raise rates. Lee anticipates a substantial market rally later this month and believes the period after the US midterm elections could deliver one of the largest advances of his lifetime
Wall Street strategist Tom Lee remains bullish despite expecting US Federal Reserve chair Kevin Warsh to raise rates. Lee anticipates a substantial market rally later this month and believes the period after the US midterm elections could deliver one of the largest advances of his lifetime.
That optimism rests on financial markets looking beyond an immediate rate increase towards future growth, liquidity and political settings. It is a bold call at a time when rising bond yields increase the discount rate applied to company earnings. If long-term yields remain around 5 per cent, shares must compete with government bonds offering returns once available mainly from riskier assets.
Japan could intensify the pressure. The Bank of Japan is expected to continue its fastest tightening cycle in decades as it tries to contain inflation and support the yen. Higher Japanese yields make domestic assets more attractive to the country’s banks, pension funds and insurers.
The Bank of Japan is expected to continue its fastest tightening cycle in decades as it tries to contain inflation and support the yen. Higher Japanese yields make domestic assets more attractive to the country’s banks, pension funds and insurers
For years, Japan supplied cheap capital to the rest of the world. If its investors begin bringing a meaningful share of that money home, demand for US, European and Australian bonds could weaken further. That would push global yields higher independently of what individual central banks do with their policy rates.
Australia therefore faces two sources of tightening. The RBA may lift the cash rate because domestic inflation remains above target. Global markets are already lifting longer-term borrowing costs because of oil, debt and changes in international capital flows.
A September increase to 4.60 per cent is now the central expectation. What follows will depend on whether the oil shock spreads into services and inflation expectations, or instead removes enough household purchasing power to slow demand sharply.
The danger is that policymakers respond to the first effect before the second becomes visible. Another rise may be defensible. A prolonged series of rises would require stronger evidence that domestic demand and wages, rather than imported energy costs and constrained supply, are keeping inflation alive.
Australia’s economy is not in recession and its aggregate figures are not disastrous. But the comfort offered by 2.1 per cent growth looks different from the household kitchen table, where wages have again fallen behind prices and another mortgage increase may be approaching.
That is the present macroeconomic trap. Inflation is too high for the RBA to relax, growth is too fragile for it to tighten without risk, and workers are being asked to accept that restoring their lost purchasing power may itself become the next reason interest rates stay high.
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