Key Highlights

  • The majority's key concern was the risk that high Inflation expectations become embedded.
  • The Board said further tightening in financial conditions was warranted to return inflation to target.
  • Today's inflation figures were less important to the decision than the expectations risk.
  • Persistent expectations could keep prices rising even as Demand slows.

Of all the sentences in the Monetary Policy Board's 3 November statement, one carries the most weight: "there is an increasing risk that higher inflation expectations will become embedded." It is the reasoning attributed to the six members who voted to raise the cash rate target by 25 basis points to 4.85 per cent. The other three members voted to hold at 4.60 per cent, and the statement gives no reasons for their view.

The majority's view followed directly: "a further tightening in financial conditions is warranted to support the return of inflation to target."

This explainer unpacks what "embedded" inflation expectations means, why central banks treat the risk so seriously, and what evidence in the RBA's November documents bears on it.

What inflation expectations are, and why they matter

Inflation expectations are simply what people believe will happen to prices in the future. They matter because they can shape behaviour today.

If workers expect prices to keep rising quickly, they may seek bigger pay rises. If businesses expect their costs to climb, they may lift their own prices sooner and further. If both happen at once, the expectation of high inflation can help produce it, independently of the original cause.

A central bank's task becomes harder when that cycle takes hold. Expectations that have drifted up, and stayed there, are what the statement means by "embedded". The concern is not a single high reading but a shift in the baseline that households and firms build into their decisions.

Governor Michele Bullock, in her opening statement to the Senate Economics Legislation Committee on 28 October, described the costs of persistent inflation in plain terms: "High inflation hurts everyone." She added: "It means higher grocery costs, higher rent, and higher electricity bills." And: "It makes everyone's pay packets and savings worth less".

Why the risk looks larger now

Several features of the current situation help explain why the majority judged the risk to be increasing.

Inflation has been above target for a long time. Governor Bullock told the Senate committee that "Inflation fell significantly from its peak of 7.9 per cent at the end of 2022", but also that "Recently, inflation has been around 3½ to 4 per cent in year-ended terms." That is still above the RBA's 2–3 per cent target range.

The return to target keeps moving further away. The statement says inflation is now expected to reach the top of the target range in late 2027, about three quarters later than previously forecast. "Inflation is now forecast to remain elevated through much of 2027," it says. The longer inflation stays high, the greater the chance that people stop expecting it to fall.

Underlying inflation picked up. Trimmed mean (underlying) inflation rose 1.0 per cent in the September quarter, up from 0.8 per cent in the June quarter, and 3.7 per cent over the year. Headline CPI rose 3.9 per cent over the year to the September quarter, and 4.3 per cent over the year to September on the monthly measure. The statement says "the data have confirmed that underlying inflation remains broadly based."

A visible price shock is under way. The November Statement on Monetary Policy (SMP) says higher energy prices from the Middle East conflict have added to inflation pressures. Fuel and electricity are prices that households notice, which can influence how they think about inflation more generally.

The SMP also provides some of the most direct evidence on how expectations are feeding into behaviour.

The RBA revised its wage price index (WPI) forecasts higher across the forecast period, citing tighter capacity, higher inflation and inflation expectations. The forecasts are now:

  • 3.4 per cent over the year to December 2026.
  • 3.2 per cent over the year to December 2027.
  • 2.9 per cent over the year to December 2028.

The RBA's liaison program, in which Bank staff speak regularly with businesses, adds colour. According to the SMP, liaison contacts report elevated wage expectations, pointing to little easing over the next year.

For context, the WPI rose 3.2 per cent over the year to the June quarter of 2026, with private sector wages up 3.1 per cent over the year.

What it would look like if expectations stuck

The SMP sets out a risk scenario that combines energy and expectations. If Crude Oil stays around US$100 a barrel with elevated refined product prices, underlying inflation would be around 2¾ per cent by end-2028, rather than about 2½ per cent in the central forecast.

That gap may look small, but it captures the concern. In that scenario, inflation does not run away; it simply settles above the midpoint of the target for longer. The SMP also notes, more broadly, that domestic inflation risks remain skewed to the upside.

The RBA's central forecasts show headline CPI inflation reaching 2.5 per cent, the midpoint of the target range, by mid-2028, with trimmed mean inflation also at 2.5 per cent in June 2028. Those are RBA forecasts, built on a cash rate path drawn from market pricing as at 28 October 2026, not a guarantee.

The Bank has also been studying how outsiders read its behaviour. A discussion paper released on 22 October is titled "Perceived Monetary Policy Rules: Evidence From Professional Forecasters in Australia". Its findings are not summarised here.

The case on the other side

None of this means the outcome is settled. The statement acknowledges that "The economy is slowing", that "housing prices have fallen significantly", and that the Unemployment rate is projected to rise by more than expected in August. The SMP notes inflation could fall faster if higher rates and falling housing prices weigh on spending.

The statement does not say whether the three dissenting members saw the expectations risk differently. It simply records their vote.

Looking ahead, the Board says it "will be attentive to the data and the evolving assessment of the outlook and risks to guide its decisions." The next CPI release is on 25 November and the next decision on 8 December.

The bottom line

The six members who voted for the November rise did so chiefly because they saw an increasing risk that higher inflation expectations would become embedded. The evidence the RBA cites includes a long period of above-target inflation, a delayed return to target, a pick-up in underlying inflation, an energy price shock, upgraded wage forecasts and elevated wage expectations among businesses. The Board's response was to tighten financial conditions further. Whether that is enough to keep expectations anchored is the question the coming data will test.