Australian Dollar: Bolstered by H1 Rate Hike Bets

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The Australian dollar is outperforming on bets the Reserve Bank of Australia (RBA) will lift interest rates in the first half of next year.

Australian interest rate expectations rose sharply across various tenors after the RBA on Tuesday held rates and indicated that the balance of risks was now leaning towards higher rates.

"The Australian dollar has been boosted by hawkish comments from RBA Governor Bullock," says a note from MUFG Bank.

AUD was relatively flat following Tuesday's initial RBA decision, but gains started to build after Governor Bullock gave a clearer steer on the direction of travel.

She's clearly worried that mounting upside inflation risks will merit a response, saying:

"I don’t think there are interest rate cuts on the horizon for the foreseeable future... the question is, is it just an extended hold from here or is it the possibility of a rate rise. I couldn't put a probability on those but I think they’re the two things that the board will be looking closely at coming into the new year."

MUFG says the comments send a clear signal that the RBA’s easing cycle has come to an end, and will encourage market expectations that the RBA’s next policy move is more likely to be a rate hike than a cut.

Australia's short-term bond yields have surged over recent weeks as bets for a higher base rate at the central bank rise. In response to these rising yields, interest-bearing products adjust, meaning domestic lending rates and mortgage rates will see a lift.

Above: Market expectations for future RBA cash rate changes, showing a cut is expected by the end of H1.

For foreign investors, Australia looks like an increasingly attractive destination in which to park capital and earn interest.

This, known as the 'carry trade', is a significant driver of foreign exchange value. In fact, research from RBC Capital Markets shows the 'carry' on Australian dollars is now at the highest level since 2017.

The below chart shows how interest rate expectations are pulling the Aussie dollar higher against the pound:

The top panel shows the two-year bond yield which reflects expectations for the central bank base rate. As it lifts, it pulls AUD/GBP higher (lower panel).

"The RBA managed to surprise hawkish against an already supportive backdrop. We remain long AUD vs EUR and vs GBP," says Alvise Marino, Senior Strategist at UBS.

Economists at Commonwealth Bank of Australia (CBA) say a rate rise could come as soon as the February decision.

"The February meeting is ‘live’.We still expect the cash rate to remain on hold from here but note risks clearly sit to higher rates in 2026," says Ashwin Clarke, Senior Economist at CBA.

His colleagues at ANZ aren't yet expecting a massive shift and see an extended hold in the cash rate at 3.60%.

"That said, in the wake of the Q3 national accounts and the October monthly CPI the risks of a rate hike in the first half of 2026 are rising," says ANZ in a post-RBA note.

To cool rate hike bets, the next few inflation prints must undershoot expectations, something ANZ thinks could happen.

"Encouringly, though, business survey-based measures of price and cost pressures are not moving higher, which gives us some confidence that inflation will ultimately trend lower over 2026," say economists.

This places a significant burden on the two monthly CPI inflation releases slated for January: November's data is released on January 07 and December's on January 28.