What’s Behind the Australian Dollar Exchange Rate Rebound: How Changing Inflation Expectations Are Reshaping Central Bank Policies?

The recent performance of the Australian dollar is worth paying attention to. On November 26, the AUD/USD exchange rate rose by 0.6% to 0.6505, marking the fourth consecutive day of gains. Seemingly ordinary numerical fluctuations, but they reflect a new market perception of the Reserve Bank of Australia’s policy direction.

What Inflation Data Changed

The latest Australian October inflation data became a turning point. The Consumer Price Index (CPI) increased by 3.8% year-on-year, exceeding market expectations of 3.6%. It may seem like a 0.2 percentage point deviation, but it changed the entire market’s expectations for RBA rate cuts.

Citi Macro’s analysis highlights the severity of the issue: there are hardly any signs of easing inflation pressures, and the probability of rate cuts being on the agenda in the short term is extremely low. If upcoming GDP data also shows rising capacity pressures, then the easing cycle is likely truly over.

This judgment is crucial. It means that the market’s previous expectations of significant rate cuts by the RBA need to be reassessed.

The Dilemma Facing the RBA

On December 9, the RBA will announce its latest interest rate decision, with the market generally expecting rates to remain unchanged at 3.60%. However, divergence appears further into the future.

Institutions have differing views on the RBA’s policy direction in 2026. Conservative forecasts suggest there might still be one rate cut, but institutions like UBS go further—they predict the RBA may hike rates in 2026.

UBS analyst Stephen Wu’s logic is clear: the current inflation upward trend is becoming increasingly evident, and the Consumer Price Index is likely to remain above the RBA’s target range for the next year. Based on this judgment, UBS expects the RBA to start hiking rates in the last three months of 2026.

Barrenjoey Chief Economist Jo Masters is more straightforward: although the threshold for rate hikes is very high, the RBA is very likely to act in 2026. “The final phase of inflation may require tighter monetary policy; there is no path to rate cuts in 2026,” which almost signals the end of rate cuts.

Why the AUD Exchange Rate Has Risen

The rebound in the AUD/USD exchange rate is not out of thin air. On one hand, the increased expectation that the RBA’s rate-cut cycle has ended makes the AUD relatively more attractive. On the other hand, positive US economic data supports the Fed’s continued rate cuts in December, further weakening the dollar.

Against this backdrop, the rise in the AUD/USD exchange rate becomes a rational choice. The market is re-pricing the policy divergence between the two central banks.

Outlook for the AUD in 2026

Regarding the longer-term performance of the AUD, analysts at ING, Francesco Pesole, are optimistic about the Australian dollar. He believes the AUD is poised to become a standout among G-10 currencies.

The reasons are twofold: first, the RBA is expected to make only one more rate cut, and by Q2 2026, the AUD will have the highest interest rate among G-10 currencies; second, improved trade relations make Australia’s growth prospects relatively positive.

These two factors combined suggest that the AUD has a solid foundation to continue rising in 2026. High interest rate differentials and growth expectations are often core factors supporting currency appreciation.

The market story is clear: high inflation in Australia has shattered the rate-cut dream, with the central bank shifting from easing to neutral or even hawkish stance, benefiting the AUD. This logical chain may continue to unfold into 2026.