Why Is the RBA Raising Rates When Unemployment Is Rising?

General information, not financial advice. This article explains how things work in general. It doesn't consider your personal circumstances. Before making decisions about your mortgage, tax or money, consider getting advice from a licensed financial adviser or registered tax agent.

On Melbourne Cup Day the Reserve Bank of Australia raised the cash rate by 25 basis points to 4.85%. If you have a mortgage, that stings. If you have been watching the job ads, it may also feel strange. The RBA itself says the economy is slowing, housing prices have fallen significantly and the unemployment rate has risen. So why push on the brakes harder when the car is already slowing down?

The short answer is that the RBA is not steering by how fast the car is going right now. It is steering by how hot the engine is running, and by where everyone in the car thinks it is heading.

The job the RBA has been given

The RBA has two goals: price stability, which it defines as inflation between 2 and 3 per cent, and full employment. Most of the time those goals pull in the same direction. When they clash, the board has to judge which risk is bigger.

Right now inflation is the bigger risk. In its November forecasts the RBA expects headline inflation to peak at around 4.5% in the December quarter and to stay above 3% until late 2027, roughly three quarters longer than it expected in August. Underlying inflation, which strips out the most volatile price moves, is also forecast to stay above 3% until late 2027. That is a long time to be outside the target band.

"Capacity pressures", in plain English

Think of the economy as a kitchen. There are only so many cooks, ovens and hours in the day. If customers order more meals than the kitchen can make, the restaurant can't simply produce more. It raises prices, or it gets slower and more expensive to run. Economists call that running above capacity.

The RBA's view is that Australia's kitchen has been running hotter than it can sustain, and hotter than the RBA previously thought. In the board's words, domestic capacity pressures "are also judged to have been a little tighter than earlier thought." Two things explain it. First, productivity growth has been weak for years, so the kitchen hasn't been getting more efficient. Second, some parts of demand have been surprisingly strong, especially business investment linked to data centres.

Rising unemployment is a sign that the kitchen is starting to cool. But an economy that is cooling from too hot is not the same as an economy that is cold. The RBA expects demand and supply to come back into balance only some time in 2027.

Why expectations matter so much

The other thing the board is watching is what we all expect. If households and businesses come to believe that 4% inflation is normal, they behave accordingly. Workers ask for bigger pay rises to keep up. Firms raise prices more readily because they assume their competitors will too. The expectation becomes the outcome.

The RBA says some measures of inflation expectations "are assessed to have risen lately", and it warns of "an increasing risk that higher inflation expectations will become embedded." Once that happens, getting inflation down usually takes a much bigger and more painful slowdown later. A smaller rise now is the board's way of trying to avoid a larger one down the track.

A close call: the 6–3 vote

The decision was not unanimous. Six members voted to raise the cash rate to 4.85% and three voted to leave it at 4.60%. That split tells you the board takes the slowdown seriously. The members who voted to hold could reasonably argue that rate rises already in the pipeline, falling house prices and rising unemployment will do the job on their own.

The majority judged that waiting was the bigger gamble, given how long inflation has already been too high. At her media conference the Governor, Michele Bullock, put it bluntly: the board is "very uncomfortable" with the situation, and that was "part of the reason why six members voted for a raise today."

What it means for you

For borrowers, a 25 basis point rise usually flows through to variable mortgage repayments within weeks, although timing and size are up to each lender. The RBA's forecasts assume, based on market pricing, that the cash rate will rise by around another 35 basis points by mid-2027. That is a market assumption, not a promise, and it can change quickly.

For workers, the RBA expects the unemployment rate to drift up to around 5.1% by the end of 2028. That is higher than today, but it is a gradual easing rather than a collapse.

The bigger lesson is about how central banks think. They look forward, not back. Today's job numbers tell them where the economy has been. Inflation expectations and capacity pressures tell them where it is going, and that is what they are trying to change.