Introduction to Inflation and Interest Rates
Repayments on mortgages and debts are likely to increase due to a higher-than-expected inflation result, which puts pressure on the Reserve Bank to lift interest rates. The speed of annual price rises accelerated at the end of 2025, picking up more than forecast and adding to expectations of rate hikes. The Consumer Price Index (CPI) rose 3.8 per cent annually in December, up from 3.4 per cent in the year to November.
What is Happening with Inflation?
The CPI rose 1 per cent in the month, and the trimmed mean, a measure of underlying inflation, rose 3.3 per cent annually in December, up from 3.2 per cent a month earlier. The RBA’s interest rate setting board will deliver its first decision of 2026 this coming Tuesday. Economists and analysts tend to agree that the ‘hot’ result makes it more likely the Reserve Bank will increase the cost of money.
Rate Hike Now More Likely
The RBA sets a key interest rate, which repayments on mortgages and debts are then calculated on. Because it wants prices to rise only between 2 to 3 per cent every year, this new data showing inflation well above that will be influential in their decision-making. Capital Economics Abhijit Surya says the sharper-than-expected rise in inflation makes it "all but certain that the Reserve Bank of Australia will raise interest rates at its meeting next week". The cost of housing, or "shelter inflation", continues to pick up, with rental inflation lifting from 3.8 per cent to 4 per cent.
Causes of Inflation
The largest contributors to annual inflation over the last 12 months were housing (+5.5 per cent), food and non-alcoholic beverages (+3.4 per cent), and recreation and culture (+4.4 per cent). The timing of electricity rebates continued to have an impact on the data, with electricity costs rising 21.5 per cent in the year to December. Excluding the impact of Commonwealth and state rebates in the past year, electricity prices rose 4.6 per cent in the 12 months to December.
What to Expect Next
BDO chief economist Anders Magnusson suggests the Reserve Bank is now "primed" to lift interest rates, as the result "reinforces the message from the September quarter" that underlying price pressures are proving more persistent than expected. The Reserve Bank raised concerns when inflation moved back above the mid-point of its 2–3 per cent target band in the back half of 2025. Ahead of the CPI release, market pricing indicated around a 60 per cent chance of a rate hike next week.
Expert Opinions
The top economist at RSM Australia, Devika Shivadekar, puts it at 55:45, meaning more likely there will be a hike than a hold. "Today’s data supports a narrative of uneven but moderating inflation, where pockets of price pressure persist, yet the broader trajectory continues to grind lower rather than justify an imminent policy response". She sees it as a "narrow call", around a 55:45 proposition, with the RBA potentially opting to move pre-emptively and hike now rather than risk having to tighten more forcefully later.
Conclusion
In conclusion, the higher-than-expected inflation result has increased the likelihood of a rate hike by the Reserve Bank. With the cost of housing and other expenses continuing to rise, it is likely that the RBA will increase interest rates to combat inflation. This will result in higher repayments on mortgages and debts, affecting many individuals and families. It is essential to stay informed about the economic situation and plan accordingly to minimize the impact of potential interest rate hikes.
