The Reserve Bank left the cash rate unchanged at 4.35% at its August meeting, after three rate rises earlier this year.
Those increases are now working their way through the economy. Growth has lost momentum, the labour market is cooling and housing has softened as higher mortgage repayments put more pressure on households. Normally, that combination would have investors starting to look towards lower interest rates. The problem is that inflation is still too high.
The RBA is trying to slow the economy enough to bring inflation under control without pushing households and businesses too far. That balancing act is becoming increasingly important for investors.
Monetary policy is how a country’s central bank helps steer the economy. Think of it as a financial thermostat.
When inflation is too high, higher interest rates cool borrowing and spending. When the economy is weak, lower rates can encourage spending and investment.
In Australia, the Reserve Bank aims to keep inflation between 2 and 3% over time.
Right now, the thermostat is still set to cool.
When we looked at monetary policy in May, the RBA had raised rates because inflation was moving in the wrong direction again. Three months later, there are clearer signs that those higher rates are having an effect.
The RBA expects growth to remain subdued through the rest of 2026 as higher rates, weaker household income growth and softer housing conditions restrain demand. Housing prices had already fallen 1.6% from their March peak when the August report was prepared.
The squeeze is showing. What we do not yet know is whether it will be enough to bring inflation down without causing a much sharper slowdown.
Since the RBA meeting, we have received another inflation reading. Annual headline inflation fell from 3.8% in June to 3.5% in July, which is encouraging.
The measure the RBA watches closely, however, has barely moved. Trimmed mean inflation remained at 3.6%.
This distinction matters because headline inflation can fall quite quickly when volatile prices move. Domestic inflation is harder to shift because it is tied more closely to housing, services, wages and business costs.
The RBA does not expect inflation to return to the middle of its 2 to 3% target range until early 2028. Inflation is moving in the right direction, but the job is far from finished.
Higher mortgage repayments and tighter borrowing conditions are making households more cautious, particularly when it comes to larger financial commitments.
Yet Australians have not stopped spending. Household spending rose 1.1% in July, the third consecutive monthly increase, and was 7.0% higher than a year earlier in nominal terms. Some of that annual increase reflects higher prices, but demand has clearly not collapsed.
This helps explain why the RBA remains cautious. Higher rates are slowing parts of the economy, while household spending is still resilient enough to keep some inflationary pressure alive. For now, the RBA appears prepared to give its earlier rate rises more time to work.
Unemployment reached 4.5% in July. That caught our attention because 4.5% was the unemployment rate the RBA had forecast for the end of 2026. We reached it several months early.
Australia does not suddenly have a weak labour market, but the direction matters. If unemployment continues to rise while inflation falls, the case for keeping interest rates this high will weaken. If inflation remains stubborn, the RBA will have much less room to respond.
From here, employment and inflation need to be watched together because the next shift in monetary policy is likely to emerge from the relationship between the two.
The latest GDP figures, released after the RBA’s August report, added another piece to the picture. Australian GDP grew 0.4% in the June quarter and 2.1% over the year.
Growth is not strong, but the economy is not in recession either. We have an economy that has lost momentum while inflation remains too high for the RBA to comfortably begin cutting rates.
For investors, that creates a very different environment from the one we became used to when cheap money was readily available.
This remains a steady pressure environment. Higher interest rates expose businesses carrying too much debt, while slower economic growth makes it harder for companies to lift earnings simply because the economy around them is expanding.
That puts more emphasis on the strength of the individual business. We are looking for strong balance sheets, manageable debt, reliable cash flow, genuine earnings growth and the ability to pass on higher costs when necessary.
We would be more cautious about businesses that depend heavily on discretionary consumer spending or need lower interest rates to make the investment case work.
Banks require a little more thought. Higher rates can support lending margins, but that benefit becomes less valuable if borrowing slows sharply or bad debts begin to rise. Property is equally sensitive to the interest-rate cycle, so investors should be wary of assuming that rate cuts will arrive quickly enough to rescue highly leveraged businesses.
While much of the economy is slowing, business investment has remained surprisingly strong, helped by spending on data centres and AI infrastructure.
Business investment increased 10.4% over the year to the March quarter, with the RBA pointing to data centre fit-outs as the main driver of that strength. It also expects data centre investment to remain high over the coming years.
This is where the story becomes more interesting for investors. Data centres need enormous amounts of electricity, transmission capacity, water, cooling systems, engineering, construction and equipment.
The Australian AI story could therefore become much broader than simply buying technology companies. It may increasingly become an energy and infrastructure story as well.
There is another issue in the RBA report that deserves more attention: Australia’s productivity growth remains weak.
The RBA is working with an assumption of medium-term productivity growth of only around 0.7% a year, while recent results have been weaker.
Productivity is simply how much we produce from the resources we use. When productivity improves, businesses can produce more without costs rising at the same pace, allowing the economy to grow more quickly without creating as much inflation.
When productivity barely improves, we hit capacity constraints sooner and inflation becomes harder to control. This is where monetary policy reaches its limits because interest rates can suppress demand, but they cannot improve productivity.
That requires investment, infrastructure, skills, technology and better ways of doing things. So while everyone watches the next RBA meeting, Australia’s weak productivity growth may prove to be the much bigger long-term economic issue.
The message from the RBA is fairly clear. Its earlier rate increases are starting to slow the economy, so for now it is prepared to watch and wait. At the same time, the Board remains concerned about upside risks to inflation and is nowhere near ready to declare victory.
That makes rapid interest-rate cuts difficult to justify unless the economy or labour market deteriorates much faster than expected.
For investors, the useful question is not simply whether rates will eventually fall. The more important question is what happens before they do.
Australia is slowing, which is exactly what higher interest rates are designed to achieve. The difficulty is that inflation is not falling quickly enough to give the RBA much room to relax.
The Bank is caught between two risks: keeping rates high for too long and doing unnecessary damage to the economy, or easing too early and allowing inflation to become a problem again.
For investors, this is not an environment in which we should assume cheap money is about to return. Rates remain high, growth is subdued and inflation is stubborn, which increases the value of strong balance sheets, sensible debt levels, reliable cash flow and genuine earnings growth.
The next few inflation and employment reports should tell us whether the balance is starting to shift. When it does, markets are likely to move before the RBA does.
Markets move on what happens next.
Our job is to recognise when the forces shaping the economy begin to change.
Read the RBA’s August 2026 Statement on Monetary Policy.
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