What to Think of Another Aussie Rate Hike

While the Fed, Bank of England (BoE) and European Central Bank (ECB) all stood pat last week, one central bank continues bucking the trend: The Reserve Bank of Australia (RBA) hiked for the third straight time Tuesday, bringing the Cash Rate to 4.35%.^[i] While we doubt this is a major economic headwind or bad news for stocks, the flaws in the RBA’s thinking are worth exploring. Understand them, and you will be able to better assess the risks of errors elsewhere.

In its policy statement, the RBA noted higher fuel prices’ effects on inflation and warned the effects could trickle through prices over the next several months as businesses offset their own cost pressures. RBA Governor Michele Bullock elaborated in her post-meeting presser, saying that, while policymakers are “looking through” pricey energy’s immediate effects, their fear of downstream implications led them to act: “We’re already seeing that many firms are facing cost pressures, they’re looking to increase prices of their goods and services. If left unchecked, higher costs get embedded into price and wage setting decisions. These second round effects could lead to even higher, and persistent inflation. If so, that would require even more tightening and monetary policy to get inflation under control.”^[ii]

So what is the problem? This logic ignores how inflation actually works, which is an error we see repeated globally. The RBA is acting now, but the Fed, BoE and ECB are all guilty of this line of thinking. They forget inflation is always and everywhere a monetary phenomenon, as Milton Friedman taught: too much money chasing too few goods and services. Unless money supply grows at a rapid clip, businesses likely struggle to pass higher costs to consumers. They probably find they lack pricing power, especially as households are trying to manage their own energy cost increases. When people cut discretionary budgets to cover pricier gas and utilities, it saps demand for other goods and services, pressuring prices. Rapid money supply growth is what gives businesses pricing power.

There is a risk here: If central banks tighten aggressively for the wrong reasons, focusing on energy prices and wages—and ignoring money supply growth—they can end up needlessly inducing a recession.

Happily, Australia isn’t there today. Its broadest money supply measure, M3, grew 8.3% y/y in March.^[iii] While that is fast relative to money supply growth rates in the US, UK and eurozone, it isn’t rapid by Australian standards. (Exhibit 1). Since 1960, the median M3 growth rate is 8.6% y/y, rendering today’s rate bang-on average-ish. Historically, this pace has been fast enough to enable steady economic growth without igniting hot inflation.

Exhibit 1: A Long Look at Aussie Money Supply Growth

Source: RBA, as of 5/5/2026. Year-over-year M3 money supply growth rate, July 1960 – March 2026.

But monetary policy moves hit the economy at a lag, somewhere around 6 to 18 months. Bullock said today she wouldn’t expect rate hikes to start showing up in the data for at least half a year. So the real question is whether rate hikes thus far are going to choke off this growth to a worrying extent. To assess this, we can check in with our old friend, the yield curve.

This curve, which plots government bond rates from short to long, is a good gauge of banks’ future lending. Banks borrow at short rates and lend at long rates, making the spread a proxy for their profit margin on new loans. This gets a little complicated in Australia, where most mortgages are floating-rate and based on the Cash Rate, but the logic generally holds for business loans, which influence business investment—a major economic swing factor. So in general, when the yield curve is “steep,” with long rates well above short, you get more lending and economic growth. Flat curves slow growth, while “inverted” curves with short rates above long tend to signal a looming credit crunch and potentially recession.

The RBA’s hikes have flattened the yield curve, but not to a worrisome degree. (Exhibit 2) Mostly, they just undo a spate of late-2025 steepening, leaving the yield curve spread about where it was last summer and autumn … or in southern hemisphere terms, last winter and spring. That was a fine time for the Aussie economy and markets.

Exhibit 2: A Year in the Life of Australia’s Yield Curve

Source: FactSet, as of 5/5/2026. Spread between Australian benchmark 3-month and 10-year Treasury yields, 5/5/2025 – 5/5/2026.

We think the real danger would arrive if central banks globally overreacted and inverted their yield curves, taking the global yield curve with them. That isn’t at hand now. Even with Australia’s curve flattening this year, the global curve has still steepened over the last six months. The RBA is an outlier.

Will it remain an outlier? No one can know now, because no central bank is predictable. We can look at market expectations using futures markets, but those aren’t airtight. We can look at central bank commentary, but that would have led you vastly astray in 2022. Central bank decisions aren’t a market function. They are a human function, based on each voting member’s biases, opinions and forecasts. Those opinions and forecasts often change with incoming data. While central bankers (including Bullock) sometimes try to set expectations, they can change their mind. The Fed, ECB and BoE did in 2022, U-turning quickly from a view that inflation would be temporary to steep, swift rate hikes.

So watch and wait. Weigh what central bankers do, and if they start taking a mallet to the yield curve, watch sentiment carefully to see if people are dismissing the risks.