When Governor Michele Bullock explained September's rate rise, she put the spotlight squarely on pressures building inside the Australian economy rather than on shocks arriving from overseas.

Oil price spikes, conflict in the Middle East and a global scramble for artificial intelligence hardware have all featured in the Reserve Bank's commentary this year. Yet when Governor Michele Bullock fronted the media on 29 September to explain the Monetary Policy Board's latest decision, one sentence stood out for where it located the problem.

"Inflation is too high and has been driven by domestic capacity pressures," the Governor said, shortly after announcing: "Today the Board decided to increase the cash rate target by 25 basis points to 4.60 per cent."

That framing matters. Imported and home-grown inflation invite different judgements about persistence, and about how much work interest rates need to do. By pointing to capacity pressures, Bullock was signalling that, in the Board's view, demand in the Australian economy is pressing up against what it can comfortably supply.

What "capacity pressures" means

In plain terms, capacity pressures arise when households, businesses and governments collectively want to buy more goods and services than the economy can produce without pushing up costs. Firms running close to full stretch, short of staff, equipment or premises, have more scope to lift prices, and more reason to, as their own costs climb.

The Board's 29 September statement said some of the upside risks to inflation it had flagged in August were materialising. Capacity pressures in the economy were on that list, alongside:

  • a broader Middle East conflict and higher global energy prices
  • AI-related demand pushing up technology goods prices
  • firms raising, or planning to raise, their prices

The statement added that short-term inflation expectations are high and that recent inflation outcomes had been stronger than expected. Some of these forces are global, but the Governor's emphasis made plain the Board does not see inflation as purely imported.

Where the home-grown pressure shows up

Several pieces of evidence in the RBA's recent communications point to an economy that is still running warm, even as parts of it cool.

Output growth has slowed, the Board said in September, but it was stronger than expected in the June quarter. Business investment and debt growth are strong. The labour market has eased broadly as expected, but from a tight starting point. In Canberra on 18 September, Bullock told the House of Representatives Standing Committee on Economics that "The unemployment rate – at 4.5 per cent – is low by historical standards" and that "the share of the population with a job is close to a record high." By the time of the September decision, she cited an unemployment rate of 4.6 per cent.

Then there is productivity. "Continued weak productivity growth means that the economy cannot grow strongly without putting pressure on inflation," Bullock told the committee. Put simply, the economy's speed limit is lower, so even moderate demand growth can test capacity. The Board's statement made the same point, noting that weak productivity constrains potential growth.

Labour costs tell a related story. The August Statement on Monetary Policy described unit labour cost growth of 3.3 per cent over the year to the March quarter as "elevated". The August minutes recorded that the near-term wage forecast had been "slightly upgraded" due to recent wage decisions and agreements.

Separating headline from underlying

Domestic pressures tend to be most visible in underlying inflation, which strips out the most volatile price movements. In the June quarter, trimmed mean inflation, the RBA's preferred underlying measure, was 3.6 per cent over the year. Headline CPI was 3.9 per cent over the same period, and the monthly CPI indicator showed headline inflation at 4.0 per cent annually in August.

On 29 September Bullock put underlying inflation at a similar level: "Inflation is about 3.5 per cent." That is about a percentage point above the 2.5 per cent midpoint of the 2–3 per cent target range.

The gap between the two readings is partly where global shocks such as petrol prices show up, because headline inflation captures them directly. Underlying inflation sitting well above target is the stronger signal that price pressures are broad-based, and that is where capacity pressures come in.

Demand, not a spiral

Pointing at domestic demand is not the same as declaring that wages and prices are chasing each other upwards. Bullock was explicit on that point at her media conference: "I concur with his view that, no, this is not a wage price spiral."

A week earlier, Monetary Policy Board member Iain Ross AO, speaking in a personal capacity at the University of Melbourne on 22 September, had concluded that "there is no evidence of the emergence of a wage-price spiral in the present circumstances".

The Board's diagnosis is therefore more nuanced. Demand is strong relative to a slow-growing supply side, firms are raising prices, and expectations of near-term inflation are high, but wages are not running away.

That diagnosis helps explain why the Board judged that "a further tightening of financial conditions" was warranted to return inflation to target within a reasonable period. Interest rates cannot lower world oil prices or the cost of AI chips, but they can influence how much Australians borrow and spend, cooling demand so it better matches capacity.

"Higher interest rates are needed to ensure inflation returns to target," Bullock said.

There are signs earlier rises are biting. The Board noted that consumer spending is easing gradually, housing prices have fallen in most capital cities and new housing loans have declined noticeably. The Governor also cautioned that "A lot of that effect is still to flow through" from the three rises earlier in 2026, with policy taking "12, perhaps even 18 months" to work through fully.

That lag is part of the balancing act. The Board said it is focused on preventing high inflation from becoming embedded, while acknowledging that uncertainty is high and the effects of the housing downturn are uncertain.

On whether the cash rate will rise again, Bullock declined to be drawn: "I'm not going to give you forward guidance." She did say that "The Board will increase interest rates again if that's what's needed to get inflation down." The next decision is due at 2.30 pm on 3 November 2026, and the Board has said it will remain attentive to the data.

The bottom line

Bullock's choice of words on 29 September was telling. By describing inflation as "driven by domestic capacity pressures", she framed the problem as one interest rates can address: demand running ahead of an economy whose productive capacity is growing only slowly. Global shocks remain part of the picture, and the Governor does not see a wage-price spiral. But with underlying inflation about a percentage point above the target midpoint, the RBA's message is that home-grown demand needs to cool, and that the full effect of this year's rises is still working its way through the economy.