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Westpac’s chief economist, Luci Ellis, has warned that inflation driven by government policy could make it difficult for the RBA to meet its inflation target without squeezing the market sector.
While the major bank remains the only big four bank to maintain a base case of two more rate cuts this cycle (one in May 2026 and another in August 2026), it has said that this is only contingent on inflation moderating over the course of 2026 – at least in the market sector – and supply capacity comes in higher than the RBA’s assumption of 2 per cent.
In a weekly update released on Monday (8 December), Ellis said that high inflation in policy-driven areas could force the RBA to keep market-sector inflation below target, with negative implications for economic growth.
“Most of the high inflation is in sectors that are insulated from monetary policy,” Ellis noted.
“The RBA can still achieve its inflation target in this environment, but only by squeezing the market sector of the economy with tight policy to offset high administered price inflation with sub-target inflation elsewhere.”
The unwinding of government rebates drove electricity prices up 37.1 per cent over the year to October 2025, data from the Australian Bureau of Statistics (ABS) showed. A recent Sydney Water pricing decision would also see utility costs rise over the medium term, while local government rates rose by 6.2 per cent over the year, Ellis noted.
“Tobacco, child care, school education, postal and medical & hospital charges all exceeded 5 per cent over the year as well,” she said.
Given that rising inflation is largely concentrated in sectors that are driven by fiscal policy – not monetary policy – Ellis said that the RBA would likely need to ‘squeeze’ the market sector to offset high administered price inflation. She remarked that this was an “unsatisfactory” way to run an economy.
“There must be a better way to keep inflation under control than to keep the boot continuously on the neck of the Australian consumer. And there is, but it requires governments at all levels to take charge of their own contribution to inflation,” Ellis said.
She expected the RBA to partially look through the recent inflation pick-up, given that it was driven by some temporary factors. However, she said the central bank would remain cautious given its views on potential output growth (which it assumes will be 2 per cent) and would leave interest rates “emphatically on hold” in December and likely for much of 2026.
Previously, the RBA has warned that the economy could be “boxed in” by its own capacity constraints, leaving little room for further interest rate cuts without significant improvements to productivity growth.
Westpac was more optimistic about the economy’s supply capacity than the central bank, Ellis noted. She said small surprises in population growth, labour market participation, or productivity could all lift the economy’s capacity, leaving more room for growth without inflation.
“If we are right about supply capacity, inflation will moderate – at least in the market sector – over the course of 2026, leaving room for the two cuts we still have pencilled in,” Ellis said.
“Given the RBA’s beliefs about potential output, this will not be its expectation. It might therefore seek to further dampen expectations of future cuts. The risk to our base case is quite obviously that the RBA stays on hold for longer.
“If we are right about supply capacity, though, the Australian economy will not hit the wall of capacity constraints. And that means the RBA risks keeping interest rates too high for too long.”
In the nearer term, Westpac expects the central bank to keep rates on hold today (9 December), as does the majority of the market.