Behind the Australian Dollar's Strong Upward Movement: Central Bank Rate Hike Cycle Initiation and Stubborn Inflation

The Reserve Bank of Australia (RBA) sent a hawkish signal this week, pushing the Australian dollar to a three-year high. The rate hike decision earlier this month has initiated an interest rate increase cycle, and Governor Philip Lowe reiterated that if inflation continues to spiral out of control, policymakers are prepared to raise rates further. These signals are driving the AUD’s strong performance, and market investors should pay close attention to potential turning points in the AUD’s future trend.

RBA Turns Hawkish, AUD/USD Breaks Three-Year High

On Thursday, the RBA publicly stated that if inflation does not improve, it is ready to raise interest rates further. Following this hawkish signal, the AUD/USD climbed to 0.7147, hitting its highest level since February 2020. This rise is not coincidental—last week, the RBA became the first major central bank globally to hike rates in 2025.

In early February, the RBA’s Board unanimously agreed to raise the cash rate target by 25 basis points to 3.85%, ending over two years of easing. The central bank cited the need to address “materially rising” inflation pressures in the second half of the year and supply-side capacity constraints. According to the latest economic forecasts, at least one more rate hike is expected in the coming months, with most economists predicting another increase in May to 4.1%.

Inflation Origins: Government Spending and Demand Imbalance

Why has Australian inflation re-emerged? According to the latest data from the Australian Bureau of Statistics, the Consumer Price Index (CPI) in December 2025 rose 3.8% year-over-year, up from 3.4% the previous month. Housing costs were the largest contributor, rising 5.5% YoY; food and non-alcoholic beverages increased by 3.4%; leisure and culture rose 4.4%. Since July last year, inflation has been on the rise, remaining above 3% for several consecutive months.

Australia’s inflation problem is characterized as “endogenous.” Over the past few years, local, state, and federal government spending has grown rapidly, while domestic labor productivity, innovation capacity, energy investment, and economic transformation progress have lagged. This has led to sustained excess demand over supply, pushing up prices. Former RBA director Roger Kobet openly stated that large government spending plans are dragging down the economy, with expansion in public services imposing significant costs on both the budget and the private sector, making economic growth difficult under these conditions.

The Double-Edged Sword of Rate Hikes: Economic Concerns Amid AUD Strength

Persistent high inflation has compelled the RBA to adopt aggressive rate hikes, which in the short term have supported the AUD. However, higher interest rates will eventually dampen economic growth. Governor Lowe admitted at the recent House of Representatives Standing Committee on Economics that government spending is a key driver of aggregate demand fueling inflation. This means that although rate hikes can curb inflation, ongoing high government expenditure will likely slow economic growth.

Investors need to weigh the short-term strength of the AUD against medium-term economic pressures. While the rate hike cycle supports the AUD, it also entails higher borrowing costs and softer consumption, introducing uncertainty into the economic outlook.

Technical Outlook for AUD: 0.7100 as a Key Pivot

From a technical perspective, the AUD/USD has maintained a clear upward trend since November last year, with a series of higher highs and higher lows indicating sustained bullish momentum. However, the market is now at a critical juncture, facing a directional choice.

If AUD/USD stabilizes above the 0.7100 level, further rebound toward 0.7300 or even 0.7500 could be possible. Conversely, a break below 0.7100 would raise risks of a pullback, potentially testing the 0.7000 psychological level or even 0.6750. Overall, the short-term resistance for the AUD remains on the upside, but the extent of its rise depends on the continuation of the central bank’s signals and inflation data developments.

Investors should closely monitor the RBA’s upcoming March meeting and subsequent inflation reports, as these will directly influence the medium-term trajectory of the AUD.