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Last week, the Reserve Bank of Australia lifted the cash rate by 25 basis points to 3.85%, marking the first tightening move since late 2023. While the increase was broadly anticipated, it represents an important shift in the policy narrative and has already begun to influence financial market expectations.

Why the Hike Happened

Inflation has remained more persistent than policymakers had hoped, particularly across services, housing-related costs and wages. Although headline inflation has moderated from its peaks, the RBA has grown increasingly concerned that underlying price pressures are not easing quickly enough to ensure a timely return to the 2–3% target band.

In that context, maintaining an unchanged policy setting risked signalling a degree of complacency. The rate increase served as a clear reminder that the RBA remains willing to act if inflation expectations show signs of drifting higher, even if doing so creates short-term volatility across financial markets.

What This Means for Financial Markets

The increase effectively resets the risk-free rate in Australia, pushing cash rates and money-market pricing higher. Interest rate futures now imply that further tightening remains possible should inflation prove stubborn into March and beyond.

This repricing has lifted yields on short-dated government securities, steepened parts of the yield curve and created renewed opportunities within domestic fixed income markets, particularly for investors seeking income now that cash returns are meaningfully positive.

Higher cash rates feed directly into higher discount rates used in equity valuation models. Companies with higher leverage or earnings profiles weighted toward the longer term are more sensitive in this environment, while businesses with near-term cash flow, pricing power and balance-sheet strength are relatively better positioned.

Equity market performance is therefore likely to become increasingly differentiated as investors reassess valuation assumptions in a higher-rate setting.

Tighter monetary conditions translate into higher borrowing costs for both corporates and households. While this is expected to temper some investment and consumption decisions over time, it also reflects the central bank’s assessment that inflation risks remain elevated.

For credit markets, the focus will be on how higher funding costs interact with earnings resilience, balance-sheet quality and refinancing needs rather than on rates alone.

Mortgage repayments have already risen in response to the hike, directly affecting housing affordability and discretionary spending capacity. These effects typically emerge gradually, but over time they are likely to cool segments of the property market and slow the pace of consumer credit growth, contributing to softer domestic demand.

What Happens Next

The RBA has deliberately avoided providing explicit forward guidance, reinforcing its emphasis on flexibility and responsiveness to incoming data. Future decisions will hinge on whether inflation continues to moderate and whether tighter financial conditions are sufficient to cool demand without materially weakening economic activity.

For markets, this shifts attention away from predicting the timing of rate cuts and back toward close monitoring of inflation prints, labour market data and broader demand indicators. As expectations adjust, volatility around key data releases is likely to remain elevated.

The BPC View

The RBA’s February decision reflects a pragmatic response to inflation that remains above comfortable levels. For financial markets, the key takeaway is that policy is not on autopilot, and asset pricing must reflect the possibility that rates remain higher for longer than previously assumed.

In this environment, disciplined capital allocation, realistic valuation frameworks and a renewed focus on balance-sheet strength become increasingly important. While higher rates create headwinds for some asset classes, they also restore income opportunities and reinforce the value of diversification as markets navigate the next phase of the cycle.

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