Jump in forecast inflation clouds interest rate hopes

The Reserve Bank has drastically lifted inflation forecasts after admitting its last estimate was off the mark, likely ruling out rate cuts until late 2026 at the earliest.

Released as its monetary policy board held interest rates steady on Tuesday, the RBA's updated economic forecasts show the battle against inflation is far from over.

Trimmed mean inflation, which removes volatile items and is the central bank's preferred measure, is now expected to climb to 3.2 per cent by December and stay there until at least June 2026.

In its August update, the bank said it expected underlying inflation to fall to around the midpoint of its 2-3 per cent target range and remain relatively steady.

Since then, September quarter inflation data came in "notably higher than expected" at one per cent, bringing the annual figure to three per cent.

The spike in inflation was partly down to temporary factors like volatile international travel prices and a one-off rise in council rates, as well as some items that were included in the trimmed mean that will be excluded in future readings.

But other factors indicate ongoing inflationary pressures in the economy.

Although unemployment also rose in September, indicators such as low underemployment, a high vacancy rate, and an increase in workers voluntarily quitting jobs suggests the labour market remains relatively tight.

"Overall, recent data add weight to the possibility - identified as a risk in the August Statement - that there is slightly more capacity pressure in the economy than we previously assessed," the statement said.

The RBA's forecast assumes interest rates will fall in line with the expectations of money market traders, which would bring the cash rate to 3.35 per cent by mid-2026.

But the statement notes that there would still be some capacity pressures in the economy, assuming the cash rate follows the market path, raising the prospect that the RBA keeps rates on an extended pause to bring the economy back into balance faster.

While underlying inflation is the bank's main focus, Australian consumers are more attuned to headline inflation, which covers the full range of prices including volatile items.

And Australians are in for a bumpy ride, with the headline figure set to take off to 3.7 per cent by mid-2026 as federal government energy rebates come to an end.

Unemployment is predicted to stay around 4.4 per cent, after bouncing to 4.5 per cent in September, while growth in Australia's gross domestic product is expected to hit its trend rate of two per cent this year, up from the previous forecast of 1.7 per cent.

The RBA also noted the global economy has been more resilient than expected in the face of US President Donald Trump's tariffs.

China, Australia's largest trade partner, has managed to find alternative markets for its exports but a slowdown in investment remains a risk to Australia's economic growth outlook.

Much will depend on what Chinese authorities land on for next year's growth target and its upcoming five-year plan, which are set to be determined in the coming months.