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Shadow Board Recommends Another Rate Hike to Contain Inflation Risk
Australia’s latest inflation data suggest that the disinflation process has stalled rather than resumed. The monthly CPI indicator remained at 3.8% in the year to January 2026, still above the Reserve Bank’s 2–3% target band, while trimmed-mean inflation rose to 3.4% from 3.3% in December. Goods inflation picked up further, largely because electricity prices rose sharply as rebates rolled off, while services inflation eased only modestly. At the same time, real GDP expanded by 0.8% in the December quarter and by 2.6% over the year, and the Wage Price Index rose 0.8% in the quarter and 3.4% over the year. With the cash rate target currently at 3.85%, the March decision comes against a backdrop of inflation well above target, firmer activity and a sharp increase in global uncertainty following the Iran-US/Israel war and the associated jump in energy prices. The RBA Shadow Board recommends the cash rate be raised, attaching a 56% probability that such a move is optimal.
Labour market conditions remain relatively firm, though no longer exceptionally tight. In January, the seasonally adjusted unemployment rate held at 4.1% and the participation rate at 66.7%. Employment increased by 17,800, with a sizeable rise in full-time employment more than offsetting a fall in part-time jobs, while hours worked rose by 0.6% over the month to 2,013 million. Underemployment edged up to 5.9%, which is consistent with some gradual easing in labour market pressure, but not with a material loosening of conditions. Forward indicators have strengthened rather than weakened: ANZ-Indeed job ads rose by 3.2% in February, after a 5.2% increase in January, to their highest level since October 2024. Taken together, these data suggest that labour demand is still holding up, although with the recent spike in inflation, real wage growth has turned slightly negative.
Australian financial conditions have tightened at the margin over the past fortnight as geopolitical risks have risen. The Australian dollar bought around US$0.70 on 13 March, with the trade-weighted index at 65.8. In sovereign debt markets, the 1-year yield was about 4.47%, the 2-year yield around 4.51%, the 5-year yield 4.63% and the 10-year yield close to 4.98%. That leaves the curve close to flat at the very short end but upward sloping further out, consistent with markets pricing a restrictive near-term stance together with the possibility of lower rates later once inflation clearly turns. Equity prices have become more volatile: the S&P/ASX 200 closed at 8,617 on 13 March, having given up some earlier gains as higher oil prices and war-related uncertainty weighed on risk sentiment. For monetary policy, the message from markets is that inflation risks have increased on both the up- and downside, complicating the Bank’s task.
Consumer sentiment remains subdued, even if it improved a little in March. The Westpac–Melbourne Institute Consumer Sentiment Index rose 1.2% to 91.6, still well below the neutral 100 mark. The detail remained mixed: assessments of family finances relative to a year earlier improved, and the “time to buy a major household item” index rose to 98.0, but expectations for the economy over the next year fell to 85.9, and the Unemployment Expectations Index rose 3.8% to 134.7 (higher values of this index mean more consumers expect unemployment to rise in the year ahead). Actual spending data tell a similar story of resilience without strength. The ABS Monthly Household Spending Indicator rose 0.3% in January after falling in December, with services spending up 1.0% but goods spending softer. Credit growth also remained firm in January: total private credit rose 0.5% over the month and 7.7% over the year, with housing credit up 0.6% and business credit up 0.5%. Households are therefore still borrowing and spending, but they remain cautious and sensitive to further shocks to rates, jobs or energy prices.
Business indicators present a more mixed but still reasonably resilient picture. NAB’s February survey showed business confidence falling back into negative territory at -1, but business conditions holding at +7, around their long-run average. Capacity utilisation, according to the NAB survey, remained elevated at 82.8%, forward orders rose to their highest level since late 2022, and the capital expenditure (capex) measure reached its highest level in three years. The survey also showed some re-acceleration in cost growth, with both purchase costs and labour costs rising at a 1.5% quarterly-equivalent pace. The Ai Group’s Australian Industry Index improved by 9.0 points in February to its strongest headline reading in four years, with the employment indicator rising to +12.8 and new orders improving to -2.1, though manufacturing remained in a contractionary state. The PMI data are consistent with continued expansion rather than weakness: the composite index eased from January’s very strong pace but remained at 52.4 in February, with services at 52.8 and manufacturing at 51.0. Overall, business-sector data do not point to recessionary conditions; if anything, they suggest that domestic demand and capacity pressures remain firm enough to keep underlying inflation sticky.
The international backdrop has become materially more complicated since the IMF’s January 2026 World Economic Outlook Update, which projected global growth of 3.3% in 2026 and 3.2% in 2027. That baseline predates the Iran war. The IMF has since said it is too early to provide a full revised assessment and will do so in its April World Economic Outlook, but it has also noted that the conflict has already disrupted trade, pushed up energy prices and increased financial-market volatility. IMF Managing Director Kristalina Georgieva has stated that, as a rule of thumb, a persistent 10% rise in oil prices through most of this year would add about 0.4 percentage points to global headline inflation and reduce global output by 0.1–0.2%. Market economists are already revising their scenarios: Goldman Sachs estimates that a temporary rise in oil to US$100 a barrel could lower global growth by 0.4 percentage points, while Barclays has raised its 2026 Brent forecast to US$85 and says prices could reprice to US$100 if disruption through the Strait of Hormuz lasts four to six weeks. This is an awkward shock for Australia because it is likely to raise near-term inflation through fuel, freight and utilities even as it weakens parts of the external demand outlook. The policy mix therefore matters. With the federal budget due in May and legislated tax cuts set to begin on 1 July 2026, fiscal decisions that emphasise savings, productivity and supply expansion would complement monetary policy; broad demand stimulus, by contrast, would make the inflation task harder for the Reserve Bank.
The Shadow Board assigns a 42% probability that holding the overnight rate at 3.85% is optimal, a 2% probability that reducing the overnight rate back to 3.6% is appropriate, and a 56% probability that raising the rate above 3.85% is warranted. The mode recommendation is for an increase to 4.10%. Compared to previous rounds, the Shadow Board’s perceived inflation risks continue to shift upwards.
Six months out, the Board attaches a 17% probability that the cash rate should be lower than the current setting of 3.85%, a 20% probability that the current setting is optimal, and a 63% probability that a higher rate is required. The mode (with a confidence probability of 28%) is for the overnight right to be set to 4.35%. At the 12-month horizon, probabilities are 36% for a lower interest rate, 17% for a rate hold, and 47% for a higher rate. Three years out, the Board attaches a 69% probability of a lower rate being optimal, 11% to the current setting, and 21% to a higher rate.
The distribution for the current recommendation compressed by 25 basis points, to 3.60%–4.60%. For the 6-month horizon, the distribution widened slightly at the top, to 3.10%–5.10%. The same applies to the distribution for the 12-month and 3-year horizons, each with a range of 0.10%–5.10%.
