RBA’s ‘narrow path’ now leads to double rate rise before Christmas

By Paul Bloxham, Chief Economist, HSBC Australia, New Zealand, and Global Commodities.

After several years of prioritising its full-employment mandate, the Reserve Bank of Australia now ought to have a laser-like focus on returning inflation to target. This may come at the cost of an economic downturn or even a recession, but the alternative, unanchored inflation, would be worse.

Based on recent public commentary, the RBA governor and senior staff have a similar view. But it remains to be seen whether the monetary policy board does, too.

Almost any way you cut it, the evidence shows that in the post-pandemic era the RBA has been more focused on full employment than getting inflation back to target. Much of this comes down to the RBA’s chosen response to the incoming economic data – what economists call the central bank’s “reaction function”. Clearly, the economy has remained fully employed, but core inflation has been above the midpoint of the target band for 4½ years.

In the immediate post-pandemic period, the governor described the approach as the “narrow pathway” strategy. With the unemployment rate falling to a multi-decade low in 2022, the RBA wanted to prioritise retaining as many jobs as possible, while still getting inflation back to target, albeit slowly.

In a recent empirical study, the RBA has been acting in a way that puts an estimated 70 per cent weight on its full-employment objective and only a 30 per cent weight on getting inflation back to target.

What may surprise some observers is that, following the comprehensive review of the RBA in 2023, the bank’s board has discretion over how it weights its employment and inflation objectives.

The current wording of the agreement between the monetary policy board and the treasurer states that “the monetary policy board can best fulfil [its] mandate by conducting monetary policy in a way that will best contribute to both price stability and full employment”.

“One of the great advantages of having inflation close to target is that the central bank is better positioned to respond to whatever shock arises.”

But the agreement does not specify how it should weight these priorities. Instead, it says that the board needs to clearly explain its choices in “how it is balancing its inflation and full-employment objectives” including “how long it expects it will be before it again meets each of its objectives and why”.

There is no denying that maintaining as close to full employment as possible is an important objective.

However, there is a well-documented trade-off between the RBA’s two objectives known as the Phillips curve. At full employment, or beyond, inflation tends to rise and remain too high – and vice versa. In short, history suggests that the RBA probably can’t have both full employment and still achieve on-target inflation.

Some observers may argue that achieving full employment should be the priority. However, by choosing to prioritise full employment over returning inflation to target faster, the RBA has taken some risks.

The key risk is that inflation expectations become unanchored. The longer inflation is off target, the less households and businesses will believe it will ever return to 2.5 per cent. And the more inflation seeps into pricing and wage-setting decisions, the harder it will be to bring it back to target.

The good news is that so far there is only limited evidence that inflation expectations are becoming unanchored. However, there is some evidence suggesting that time is running out for a measured return of inflation to target.

Another risk is that the approach has reduced the central bank’s own options.

One of the great advantages of having inflation close to target is that the central bank is better positioned to respond to whatever shock arises.

After all, no one knows what the next economic shock will be and whether it will push inflation higher or lower. For example, the Middle East conflict has driven inflation higher, as did the COVID-19 pandemic, but before 2020, the challenge for Australia was that inflation was persistently too low.

The RBA is now in a tricky spot. Growth is already weakening, and inflation is still too high. But, as we see it, having had an extended period of inflation above target, the RBA now needs to prioritise getting inflation down.

This means we expect further rate rises, but this risks pushing the economy into a recession, particularly given that housing prices are already falling markedly. There is unlikely to be a narrow pathway this time.

The RBA should aim to keep inflation closer to its target more often, even if it means placing less weight on its full-employment mandate.

Getting inflation back to target should now be the priority. Expect a rate rise on September 29, followed by another in November.

This article first appeared in the Australian Financial Review on 23 September 2026.