The RBA's decision to leave the cash rate unchanged came as no surprise to the market, but the focus was always going to be on the RBA's take on the recent dataflow.

In the event, the Monetary Policy Board conceded that part of the recent lift in underlying inflation "may be persistent", but also that some was due to "temporary factors". On activity, "private demand has strengthened, driven by both consumption and investment", and, if it were to persist, would "likely add to capacity pressures". Though the "risks to inflation have tilted to the upside" in the RBA's view, they do not appear to be in any rush to pre-emptively react to these risks, noting that "it will take a little longer to assess the persistence of inflationary pressures."

Underlying the RBA's assessment on the balance of risks is a somewhat more pessimistic view on supply capacity which, in the context of an economic upswing, begets a more hawkish tone around the inflation outlook. Our view on productivity, population and participation is more constructive, implying that the economy can handle a higher rate of growth without sparking excessive inflation. As temporary factors wash out, inflation should resume its trajectory toward the mid-point of the target range, providing scope to deliver two more rate cuts next year. If inflation dynamics take longer to normalise, the risk is that the cash rate could remain on hold for longer than our current base case.

Developments around the labour market will also be key for policy hence. The data continues to speak to a gradual softening as jobs growth across broad industry segments normalises. The November update revealed a decline in employment (–21.3k) which was 'cushioned' by an unexpected fall in the participation rate, resulting in the unemployment rate holding steady at 4.3%. We expect a bit more slack to open up over the next year, putting a lid on any upside risks to inflation stemming from the labour market.

Before moving offshore, a final note on business. The latest NAB business survey indicated that business conditions remained positive and generally steady around long-run average levels in November, notwithstanding a small decline. Business confidence was a little shakier in the month, but a more constructive picture around forward orders has allowed businesses to remain cautiously optimistic. As evidence of a sustained recovery continues to build, businesses will be able to expand capacity with a greater degree of confidence.

In the US, the FOMC cut the fed funds rate by 25bps to 3.625% at their December meeting but maintained its projection of only one further cut in 2026 and another in 2027, reaching a broadly neutral rate of 3.125% by end-2027. This cautious approach reflects expectations of above-trend growth through 2028, supported by real income gains and AI-driven infrastructure investment, seeing the unemployment rate ease back to 4.2%.

Inflation is only forecast to decline gradually from 3.0% in 2025 to 2.0% by 2028, implying moderately restrictive policy will achieve the dual mandate, eventually. We anticipate capacity constraints and persistent inflation risks will limit further easing by the FOMC to just one more cut, which is most likely to be seen in Q1 2026 before inflation proves more persistent than the Committee currently expects. The fed funds rate on hold at 3.375% with persistent inflation risks is likely to bias up long-term yields, particularly amid elevated fiscal uncertainty.

The Bank of Canada subsequently kept rates steady at 2.25%, maintaining an accommodative stance to support the economy as it navigates excess capacity and trade uncertainty. The Governing Council remain confident inflation will remain at target with the inflation rate having held close to their target of 2.0% for over a year and excess capacity and softer wage growth likely to offset any upside risk to consumer prices from trade. The labour market has strengthened in recent months but still remains weak compared to where it was prior to the pandemic.

In China meanwhile, consumer inflation accelerated to 0.7%yr in November as producer prices deflation became more even entrenched, with prices down 2.2%yr. The rise in consumer prices reflects increases in the cost of food and gold jewellery versus demand-led inflation which there is little-to-no evidence of. Further support centred on household consumption should broaden consumer inflation through 2026.

Producer prices are unlikely to sustainably grow until capacity tightens, however. This could be a long way off. 'Anti-involution' policies champion profitability, but this does not preclude new more productive supply being invested in to replace old ineffective capacity or to meet demand for new goods and services. Price declines and profitability can therefore co-exist sustainably.

Source: Westpac Banking Corporation