Key points
- Underlying inflation, which removes volatile price changes from the consumer price index (CPI) came in above the Reserve Bank of Australia's expectations in the December quarter, backing the case for RBA to lift rates.
- The unemployment rate has fallen, suggesting the labour market may be tightening again and adding pressure to inflation.
- Household spending has been stronger than anticipated, pointing to more momentum in the economy than the Reserve Bank had forecast.
The Reserve Bank of Australia is widely expected to increase the cash rate by 25 basis points to 3.85 per cent when it meets next week, following a surprise uptick in underlying inflation.
Trimmed mean inflation, the RBA's preferred measure of underlying inflation, which smooths out unusually large price moves to give a clearer read on persistent inflation, rose 0.9 per cent in the December quarter and 3.4 per cent over the year. Both results are slightly higher than the Reserve Bank had expected.
"The latest inflation data confirms that price pressures, while easing, are still too high," said Belinda Allen, Head of Australian Economics at CBA.
"The accumulation of evidence supports our view that a cash rate hike is needed to ensure inflation returns to the midpoint of the target band by the end of 2027."
Labour market and household spending add to inflation pressures
The unemployment rate fell to 4.1 per cent in December, while employment continued to rise. CBA economists say these early signs of the labour market tightening for employers may make it more difficult for inflation to cool quickly.
At the same time, household consumption has been more resilient than expected, growing by an estimated 2.8 per cent over the year.
"These areas of strength suggest the economy has more momentum than the Reserve Bank anticipated just a few months ago," Allen said.
Forecast changes expected in RBA's next Statement on Monetary Policy
The Reserve Bank will release updated economic forecasts next week. CBA expects near‑term upgrades to growth, inflation and employment, although tighter financial conditions, including a rise in Australia's Trade Weighted Index, are likely to weigh on activity over the longer term.
Not a done deal - but risks lean towards higher rates
While a February rate rise remains the base case for most economists, the RBA's board could still pause interest rate changes if it wants to see more data or respond cautiously to global uncertainty.
However, domestic momentum and the latest inflation reading are expected to tilt the decision towards an increase in the official cash rate, CBA economists say.
See Belinda Allen's full analysis here .
