Businesses Cautious as Inflation Rises
The Australian Bureau of Statistics reported headline inflation of 3.8 per cent in the year to December, up from 3.4 per cent in November. This move has materially shifted expectations around interest rates and economic momentum in 2026.
From an investment perspective, the composition of inflation is as important as the headline number. Goods inflation lifted to 3.4 per cent, driven largely by a sharp 21.5 per cent rise in electricity prices following the unwinding of federal and state rebates. These pressures point to persistent cost inputs for energy-intensive industries and food supply chains, with limited scope for rapid reversal. Services inflation accelerated more sharply, reflecting strong pricing power in domestic travel, rents and hospitality.
For corporates, this environment suggests margin pressure will remain elevated. Higher input costs, particularly energy and wages embedded in services inflation, are likely to challenge earnings growth unless firms can successfully pass through price increases. At the same time, consumer balance sheets are under renewed strain. Analysts estimate the combined impact of inflation and potential interest rate hikes could add more than $2,000 to annual household costs, constraining discretionary spending and increasing demand sensitivity to price.
Financial markets have reacted swiftly. Following the data release, expectations for a February rate hike by the Reserve Bank of Australia jumped, with markets now pricing a roughly 70 per cent probability of a 25-basis point increase. Economists increasingly view a rise to a 3.85 per cent cash rate as the base case, with a non-trivial risk of a second hike later in the year should inflation remain sticky. For investors, this reinforces the likelihood of a higher-for-longer rate environment, which typically favours cash, defensive equities and companies with strong balance sheets and pricing power, while pressuring highly leveraged sectors.
The trimmed mean inflation figure, which strips out volatile items, rose 0.9 per cent in the December quarter, underscoring that underlying inflation remains above the RBA’s comfort zone. This strengthens the central bank’s justification for tightening, even at the risk of slowing growth. For property markets, higher rates and rising rents present a mixed picture: income growth for landlords may persist, but borrowing costs and affordability constraints could cap capital gains.
Overall, the resurgence of inflation reintroduces macro uncertainty that investors had begun to discount. Portfolio strategies in 2026 will need to account for renewed rate volatility, cautious consumers and an operating environment where cost discipline and pricing strategy become decisive factors in business performance.
