Fears interest rates will have to be hiked in 2026 as consumer, government spending fuel inflation

Soaring consumer spending ahead of the busy Christmas season and Labor’s big spending have sparked fears interest rates will have to be hiked to levels last seen almost two decades ago to stop inflation from getting even worse.

Household spending increased by 1.3 per cent in October, which was the biggest monthly increase since January 2024 and more than double the 0.6 per cent rise economists had expected.

The annual increase of 5.6 per cent was the highest in two years and well above the 3.8 per cent inflation rate.

The Reserve Bank of Australia is battling inflation on several fronts, from heightened consumer activity to excessive government spending at a Federal and State level, which the Parliamentary Budget Office on Thursday warned would stop Treasurer Jim Chalmers from being able to deliver another surplus Budget within the next four years.

Dr Chalmers has rejected a suggestion Government spending was too high.

“Well, it’s rubbish,” he said. “Private demand has now contributed more to growth in our economy than public demand for four quarters in a row.

“In fact, in the quarter just gone, the private economy made a three times bigger contribution than public spending.”

But with inflation already well above the RBA’s 2-3 per cent target, Judo Bank’s chief economic adviser Warren Hogan, who has previously worked at Treasury, said the Reserve Bank would now be likely to hike rates in February, March and May next year.

His prediction of 75 basis points of increases by mid-year would reverse the RBA’s three cut rates in 2025, and return the cash rate to 4.35 per cent. Stubborn inflation could see the cash rate rise to 5.1 per cent by 2027 for the first time since 2008, with six hikes in total from early 2026.

“I’m praying that it doesn’t have to go higher,” he told The Nightly.

“Every month they delay, starting the process of getting interest rates at the right level, is it raises the chance they have to do more.

“Today’s data just reinforces it once again: the consumer is out there spending again. Right now, it tells you inflation is not going away.”

AMP economist My Bui said rate cuts were now off the table in 2026.

“Today’s data underscores the RBA’s view that household spending is recovering and there is some ‘tightness’ in the supply capacity of the economy,” she said.

“We think that there is still some fragility given the noisy nature of the data but acknowledge that the Reserve Bank will likely remain on hold for the foreseeable future, given robust spending data, higher than expected inflation, and an unemployment rate of 4.3 per cent.”

EY chief economist Cherelle Murphy said the RBA’s three rate cuts in February, May and August had encouraged Australians to buy more non-essential discretionary goods.

“This enticed consumers to spend more on clothing, footwear, furnishings and electronics, while major concerts and cultural festivals held during the month also led to a strong lift in accommodation services,” she said.

Goods inflation is now becoming a problem with the latest Australian Bureau of Statistics data on household spending showing the amount spent on clothing and footwear had surged by 3.5 per cent in October alone, followed by a 3 per cent monthly increase on furnishings and household equipment which includes electronics.

New South Wales had the biggest monthly spending increase of 1.6 per cent, followed by Queensland and the Australian Capital Territory on 1.5 per cent but this followed a weak September.

Over the year across Australia, the broad miscellaneous goods and services category soared by 9.4 per cent, covering everything from haircuts to childcare, jewellery and financial services.

Health costs soared by an annual pace of 7.5 per cent, ahead of recreation and culture on 7.3 per cent, food on 7 per cent and hotels, cafes and restaurants on 6.4 per cent.

Ms Murphy said a low jobless rate could also give sellers of goods and services an excuse to put up their prices, which potentially adds to inflationary pressures in the economy.

“The Reserve Bank will be concerned that businesses will continue to increase prices at a rate higher than it can tolerate,” she said.

Government spending

Adding to Australia’s inflation woes, the Parliamentary Budget Office on Thursday noted the Federal Government and the states and territories were further in deficit “despite improved forecast revenue in each jurisdiction”.

This would make it harder for the Commonwealth to return to a Budget surplus in the next four years.

“Both revenue and expenses have increased compared to earlier forecasts, but the larger increase in expenses has more than offset the improvements in revenue,” it said.

“Compared to last year’s forecast of a rapid return to a national net operating surplus, the latest Budget forecasts result in continued deficits over the forward estimates.”

Dr Hogan said excessive Government spending was fuelling inflation by driving up costs for the private sector.

“Recurrent spending is leaving virtually no room for the private sector to grow,” he said.

“In reality, the Government needs to actually start cutting back. Government spending growth needs to go negative.”

The warnings were issued a day after Reserve Bank of Australia Governor Michele Bullock warned bigger Budget deficits were raising the neutral cash rate, which was neither stimulating nor curbing demanding in the economy.

ANZ economists Aaron Luk, Sophia Angala and head of Australian economics Adam Boyton said strong consumer activity during October and last month’s Black Friday sales could mean a more subdued December in the lead-up to Christmas.

“There is some risk that the earlier start to promotions pulled some spending into October from November, which suggests this result is unlikely to be repeated next month,” they said.