The Reserve Bank of Australia has surprised markets and lifted the cash rate by 25 basis points to 3.85%, signalling more hikes “may be required” to get inflation back down.

It’s not that the pace of price growth isn’t cooling – the latest ABS Consumer Price Index shows annual inflation eased to 7% in the March quarter from 7.8% in December. 

Core inflation, which strips out one-off, irregular price movements - and the RBA's preferred measure of inflation - also dipped to 6.6% from 6.9% the previous quarter.

But that’s still well above the RBA’s target band of 2-3%, and the central bank's latest forecasts don't see inflation returning to the top of that range for a couple of years.

In a post-meeting statement RBA governor Philip Lowe said getting inflation back to target “within a reasonable timeframe” is important.

“The Board’s priority remains to return inflation to target,” he said.

“Given the importance of returning inflation to target within a reasonable timeframe, the board judged that a further increase in interest rates was warranted today.”

Lowe flagged services price inflation, which is generally quite sticky and includes things like rents, medical services, travel and restaurant meals, presents “upside risks”.

Services inflation recorded its largest annual rise since 2001, last week's CPI data showed.

It marks the eleventh interest rate rise in the space of a year – the fastest tightening cycle in decades.

Markets had been pricing in only a 12% chance of a hike at Tuesday’s meeting, prompting a selloff on the ASX, with the S&P/ASX 200 posting its largest one-day loss in more than six weeks. The Australian dollar jumped more than 1%.

At 3.85% is the RBA done?

Depending on how the economy and inflation evolves, Lowe says some further tightening may be required.

While most economists expect the cash rate has now peaked, ANZ says Lowe’s emphasis on getting inflation down within a reasonable timeframe, and concerns over the stickiness of services inflation warrant a further interest rate rise in August, to a terminal rate of 4.1%.

“Ultimately, discomfort about the rate of decline in inflation and the bank’s June 2025 inflation forecast remaining at 3% (to be published ‘formally’ in the Statement on Monetary Policy on Friday) appears to have pushed the Board into a hike today,” ANZ head of Australian economics Adam Boyton says.

“Given our own concerns about the stickiness of services and non-tradables price inflation, the robustness in the labour market and the business sector, we will retain a 25bp rate hike for August.

“The risks around that will be the RBA moving earlier and/or further. Given our views on the outlook for the economy, any easing is quite considerable time off.”

Others warn further hikes risk pushing the economy into recession and say rate hikes may be needed before the end of the year.

“It takes time for rate hikes to fully flow through to spending and hence to inflation and not enough time has passed since the March hike to assess the impact of the ten prior hikes,” says AMP chief economist Shane Oliver.

“Continuing to raise rates from here adds to the rising risk of plunging the economy into a recession.

“Either way our assessment remains that by year end or early next year the RBA will start to cut rates to help the slowing economy as inflation starts to fall more than it expects.”

CBA head of Australian economics Gareth Aird – one of the few economists who’d correctly called Tuesday’s rate hike – also expects rate cuts later this year, tipping inflation will fall more quickly than the RBA anticipates.

“The RBA’s rapid rate hikes over the past year will have a big impact on the demand for goods and services in the economy and by extension price changes in 2023 and 2024,” Aird says.

“In addition, there is still organic tightening to come in the pipeline as the big fixed-rate home loan rollover continues in 2023 and 2024.

“The step change from ultra low fixed rate home loans to significantly higher floating or fixed rate loans will drain the cash flow of many home borrowers and spending decisions will shift.”