Given all the levers the Reserve Bank (RBA) has at its disposal to manipulate the economy, cynics could be forgiven for concluding that its ability to rein in inflation ‘blows big ones’.
Early last week, we learned that headline inflation rose by 3.8% in October, up from 3.6% in the previous month.
The trimmed mean - often a better indication of the underlying trend – also rose from 3.2% year-on-year in September to 3.3% year-on-year in October.
Housing inflation was the largest contributor to headline inflation, accounting for 1.2 percentage points of the 3.8% number.
Housing inflation
Rising inflation numbers took analysts by surprise with the dropping off of previous subsidies, which dampened prices, resulting in electricity alone - a major contributor to housing inflation - accounting for 37.1% in the 12 months to October.
Based on the ABS’s long-awaited first “full” monthly consumer price index (CPI) – a major milestone for Australia - which provides a more timely and accurate gauge of the short-term challenges confronting the 87 components in the CPI basket, the RBA appears unlikely to lower interest rates soon.
Having concluded that the recent spike in inflation data is largely down to temporary factors, the RBA is going to continue to focus more on year-on-year rates of growth than the new monthly data sets.
Nevertheless, RBA governor Michele Bullock noted there could be some “signal” amid the noise in the data in the form of rising housing and market services prices, which could indicate inflation was more entrenched.
Next RBA move could be up
But instead of assuming the RBA will simply kick the can for the next rate cut further down the road, some economists are now speculating that the next rate move by the RBA could be higher, not lower.
In light of recent inflation data, a growing chorus of economists, including Barrenjoey Capital Partners’ chief economist, Jo Masters, and her peer at HSBC, Paul Bloxham are now questioning whether the RBA is already overreaching with rate cuts.
Meantime, Bloxham has a more granular approach to recent numbers than the RBA appears willing to take.
Bloxham believes this week’s inaugural monthly data – which shows core inflation moving higher - should be more concerning to the central bank, especially given that it was already well above its 2-3% target band.
“To us, they add one more incremental piece of evidence to suggest that the RBA will be unable to cut its cash rate further in this cycle," he said.
“A debate can be had about whether the RBA has already cut its rate too far.”
Bloxham notes that the movement of rates from 4.1% in February 2025 to 3.6% as of November was far more active than the RBA was during 2024, when no rate movements were enacted.
When in doubt
Based on new monthly inflation data, Bloxham has moved from expecting rates to be on hold until 2027 to expecting rate hikes much sooner.
EY chief economist Cherelle Murphy also doubts the RBA will lower rates at its interest rate meeting on December 9, its last meeting before the summer break.
She suspects the RBA may decide to sit on its hands until it gets a better reading on whether the full impact of the three 25 basis point rate cuts delivered this year has been fully digested by the economy.
"If the re-acceleration in inflation is sustained over coming months — recognising that the monthly number may be exhibiting some volatility — interest rate hikes are more likely than cuts in 2026," she warned.
However, given that the October numbers may overstate the inflation picture, Shane Oliver, chief economist at AMP, suggests it is simply too early to start talking about rate hikes, especially given the rising trend in unemployment and fragile state of economic growth.
“But what we’ve seen here makes it impossible for the RBA to consider cutting interest rates in December and it substantially reduces any chance of another cut next year,” said Oliver.
“But if the various business surveys are correct, they suggest that maybe the inflation numbers will start to fall off in the months ahead.”
Impact on equities
With the likelihood of interest rates rising in 2026, investors buying ASX shares would do well to review their current and planned shareholdings today.
While all companies come with their own unique risk and reward profiles, some market sectors tend to perform better than others when borrowing costs increase.
Historically, higher interest rates put downward pressure on equity valuations, reduce cash flow and potentially lower profit margins.
As a general rule, ASX value shares often outperform ASX growth shares during periods of monetary tightening.
You may wish to consider increasing your exposure to consumer staples like Coles Group Ltd (ASX: COL) and Woolworths Group Ltd (ASX: WOW) shares and decreasing exposure to ASX consumer discretionary shares.
A lot of ASX tech stocks – often priced with future earnings in mind – could also come under pressure if the RBA does raise interest rates in 2026, as higher rates increase the present cost of investing in those future earnings.
The recently rebounding ASX property stocks could also take a hit under this scenario.
However, ASX bank stocks could benefit, as higher rates enable them to improve their net interest margins, assuming there’s no deterioration in the economic outlook.
