RBA Raises Rates to 3.85% as Inflation Reignites, Ending Australia’s 2025 Easing Cycle

Australia’s central bank has raised interest rates for the first time in more than two years, breaking from other major economies and reversing part of last year’s cuts as it confronts a new flare-up in inflation.

The Reserve Bank of Australia (RBA) on Tuesday lifted its cash rate target by a quarter percentage point to 3.85%, up from 3.60%, following its first policy meeting of 2026 in Sydney. The decision, which the board said was unanimous, ends a short-lived easing phase in 2025 and makes Australia one of the first advanced economies to resume tightening after the post-pandemic inflation surge.

In a statement, the RBA said inflation had “picked up materially in the second half of 2025” and was now “likely to remain above target for some time.” The board said it judged that “a further rise in interest rates is necessary to return inflation to target within a reasonable timeframe.”

A local rate hike, a global outlier

The 25-basis-point move comes as the U.S. Federal Reserve, the European Central Bank and the Bank of England have all held rates steady or trimmed them after inflation eased back from earlier highs.

The Fed last month kept its benchmark federal funds rate in a range of 3.5% to 3.75% after three cuts in 2025, signaling a patient stance as U.S. inflation drifts closer to its 2% goal. The ECB has left its main rates around 2.5% since reducing them in early 2025, while the Bank of England has gradually lowered borrowing costs from 4.5% to 3.75%.

By contrast, Australia now finds itself tightening again. The RBA’s move follows three cuts in 2025 that had taken the cash rate from 4.35% down to 3.60% as inflation briefly returned to its 2% to 3% target band.

Those cuts were initially framed as a cautious step toward normalizing policy after an aggressive hiking cycle in 2022 and 2023. In February 2025, when the cash rate was first reduced to 4.10%, the bank pointed to moderating underlying inflation and subdued private demand, saying the “risks to inflation have become more balanced.” Further reductions in May and August brought the rate to 3.60%, with underlying inflation then near the middle of the target range.

That narrative has now shifted.

Inflation re-accelerates

Official figures show consumer prices rising faster again by the end of 2025. Headline inflation reached 3.8% in the year to December, up from 3.4% in November. The RBA’s preferred underlying gauge, trimmed-mean inflation, climbed to about 3.3% to 3.4%, above earlier forecasts.

The central bank said the pickup was “broad based” across services, retail goods and construction. Services prices are rising faster than goods, with annual services inflation running at just over 4% compared with about 3.4% for goods. Housing costs, including rents and new dwelling construction, have been among the largest contributors, alongside food and recreation.

In its latest Statement on Monetary Policy, released alongside the decision, the RBA projected that inflation would rise further to around 4.2% by June 2026 before gradually easing. It expects inflation to return to the 2% to 3% target band only in the second half of 2027 and to be around 2.6% by mid-2028.

If those forecasts are borne out, Australia will have experienced roughly seven years of above-target inflation since 2021.

Growth has also proved stronger than the bank anticipated when it started cutting rates. Gross domestic product grew by about 2.1% over the year to the September quarter of 2025, roughly in line with estimates of the economy’s potential. More recent indicators suggest activity picked up in the second half of the year, with the RBA describing private demand as “especially strong.”

Labour market conditions remain relatively tight. Unemployment is slightly lower than the bank had forecast, underutilization is still low, and while official wage measures have eased from their peak, broader wage growth and unit labour costs remain elevated.

“On balance, the data indicate that capacity pressures in the economy are greater than previously assessed,” the board said.

Markets had largely priced in the move

Financial markets had shifted in recent weeks to expect a February hike after the stronger-than-expected December inflation print. A majority of bank economists publicly forecast a 25-basis-point increase.

Australian government bond yields rose modestly on the decision, while the Australian dollar strengthened, trading above 70 U.S. cents after the announcement. Shares on the benchmark S&P/ASX 200 index slipped slightly, though analysts described the equity reaction as muted given the move was widely anticipated.

Major lenders, including the Commonwealth Bank of Australia, National Australia Bank, Westpac and ANZ, moved quickly to pass the increase through to variable-rate mortgages, announcing they would lift their standard variable home loan rates by the full 0.25 percentage point.

For a borrower with a A$600,000 variable-rate mortgage, the change adds roughly A$90 a month to repayments, based on common media estimates. On a A$500,000 loan, one outlet calculated the annual hit at just under A$1,000.

Households in the crosshairs

The renewed tightening is set against a backdrop of high household debt and a housing market that has regained momentum since the 2025 rate cuts.

Australia has one of the highest household debt-to-income ratios in the developed world, and a substantial share of mortgages are on variable or frequently repriced rates. That makes households particularly sensitive to changes in official borrowing costs.

Housing-related prices have been among the strongest contributors to inflation. Official data show housing costs up about 5.5% over the year to December, with rents rising close to 4%. The RBA has noted that lower rates through 2025 helped drive a pickup in housing activity and prices, while capacity constraints in construction have kept building costs elevated.

Renters, who do not benefit from lower mortgage rates, have also been hit by rising housing and energy costs. Economists say higher interest rates can contribute to higher rents when leveraged landlords seek to recoup increased financing costs, although weaker investor demand over time may temper price growth.

Welfare organizations and some lawmakers argue that relying heavily on interest rates to control inflation places a disproportionate burden on younger households and recent homebuyers.

Government walks a fine line

Treasurer Jim Chalmers described the RBA’s move as “a tough decision” for Australians with mortgages but said the government respected the bank’s independence and had sought to avoid adding to inflation pressure with its budget settings.

“We know that every rate rise makes life harder for people already under the pump,” Chalmers told reporters in Brisbane. “Our job is to make sure budget policy is helping, not hurting, the fight against inflation.”

The federal opposition seized on the hike to criticize both the government and the central bank. Coalition treasury spokesman Angus Taylor said last year’s rate cuts had gone too far, forcing the bank into what he called an avoidable U-turn, and argued that the government had not done enough to tackle housing supply constraints.

Economists are divided on whether the 2025 easing will ultimately be remembered as a policy error. Some say the RBA acted appropriately based on the information at the time, as inflation appeared to be moving securely back into the target band and growth had weakened. Others contend that the bank underestimated the persistence of domestic price pressures, particularly in services and housing, and that it is now having to re-tighten in more difficult political circumstances.

More hikes to come?

The RBA’s own published forecasts incorporate an assumed path for the cash rate that follows market pricing, which currently implies the possibility of further modest increases, with the rate edging above 4% over 2026 and 2027.

Some commercial banks now expect at least one more hike later this year if inflation evolves as the RBA anticipates. Others argue that Tuesday’s increase may be enough, warning that the full effect of earlier tightening has yet to be felt and that over-tightening could slow the economy more than necessary and push unemployment higher.

The central bank acknowledged the trade-offs but stressed the importance of returning inflation to target.

“The Board is seeking to establish a more sustainable balance between supply and demand in the economy,” it said. “This is necessary to reduce the risk of high inflation becoming entrenched in people’s expectations.”

The RBA expects the unemployment rate to rise only gradually, to around 4.2% to 4.5% over the next few years, from levels that are still historically low.

A long fight, not yet over

The decision underscores how uneven the global retreat from high inflation has been. While goods prices and supply chain disruptions have largely normalized, services inflation tied to local housing markets, labour costs and capacity constraints has proved harder to tame.

For Australia, the return to rate hikes suggests that the battle to restore price stability may be longer and more complex than policymakers or households had hoped when inflation first slipped back into the target range last year.

As one of the first central banks to ease and now one of the first to tighten again, the RBA’s experience will be closely watched in other capitals. For millions of Australian borrowers, the more immediate reality is simpler: a cost-of-living squeeze that was expected to ease in 2025 has entered another round, with their mortgage statements once again bearing the brunt of the inflation fight.