The RBA keeps hiking interest rates – but are the rate rises actually working?

Interest rates have risen to 15-year highs and are pushing up mortgage default risks – but household spending is still growing.

Economists say the surprising result shows this year’s four rate hikes have not yet fully hit the economy and may be less effective at fighting inflation than they used to be. If true, that could mean more interest rate rises are on the way.

What is the RBA trying to achieve by increasing interest rates?

The Reserve Bank has increased its key cash rate to cut household spending and discourage businesses and workers from seeking higher prices and wages. It aims to bring inflation back under 3%.

Financial institutions now face higher funding costs and have responded by lifting the rates they charge for home loans, business loans or bonds for big companies.

But eight months on from the year’s first rate rise in February, spending is not going backwards.

Economic activity has slowed, businesses are less efficient and real wages are going backwards compared with a year ago as inflation rises. But Australian household spending has accelerated, up nearly 7% compared with a year ago, according to Australian Bureau of Statistics estimates.

Part of the increase in spending is from higher prices for essentials such as fuel and food. But it also reflects strong demand for electric cars and non-essentials – particularly overseas travel.

Inflation has risen to 4% as of August, both because of oil disruption and mass construction of big projects like datacentres and because local businesses are lifting their prices. When customers are willing to spend big, businesses find it easier to raise prices.

Do higher mortgage rates cut household budgets?

The cash rate’s most immediate effect is on household cashflow, taking money away from borrowers while giving more to debt-free savers.

RBA data shows higher rates and prices have left 2% of borrowers unable to afford essential expenses but most people are meeting repayments.

Warren Hogan, the managing director of EQ Economics, says the emergence of mortgage offset accounts in the last decade has reduced rates’ effect on cashflow. Borrowers who have spare cash in offset accounts, often because they can afford to pay more than their minimum, now have “massive buffers”. Australians now hold nearly $350bn in total in offset balances.

“You just didn’t have the same amount of capacity to pay off earlier and have offsets accounts and all that sort of thing,” Hogan says.

Home ownership is in decline, meaning more Australians are renters whose spending is not directly hit by higher mortgage rates.

One in three households own their home debt-free and benefit from higher interest on their savings. Commonwealth Bank data indicates older Australians and debt-free homeowners have steadily increased their spending this year.

Will falling house prices discourage spending?

The slide in house prices is a sign that interest rates and higher borrowing costs are directly restricting economic activity, according to David Bassanese, the chief economist at BetaShares.

House price slides are also an indirect channel for hikes to slow spending as homeowners tend to cut back when falls in home values make them less wealthy than they had been. RBA research suggests a 10% fall in housing prices – which is expected by mid-2027 – will cut consumption by 1.5%.

Bassanese says consumer spending does not appear to have slowed yet by as much as past RBA models would imply. “We’re probably not seeing a major effect yet, but in theory, it should be starting to happen,” he said.

The “wealth effect” of interest rates is typically slower-moving than the cashflow effect.

But most homeowners are also wealthier than they were two years ago, with the median national price back to where it was in September.

What about exchange rates?

The Reserve Bank says the most important effect of interest rate rises is through the exchange rate. Higher interest rates tend to push up demand to invest in Australia, lifting the Australian dollar, making imports cheaper.

But the dollar has been fairly stable against other currencies because foreign central banks like the US Federal Reserve are also lifting their own interest rates.

The Australian dollar rose from 65 US cents in November 2025 to 72 in May 2026, after the first three RBA rate rises but has fallen to 69 US cents. It’s followed a similar path compared to an index of Australia’s trade partners, include China, Japan, Europe and South Korea.

“We’re raising rates, but so is everybody else,” Bassanese says. “Our currency is not especially strong, although it has lifted somewhat over the past year.”

How does higher unemployment stop inflation?

Interest rate rises aim to push up unemployment but the hikes have had little effect this year.

More jobseekers make it easier for businesses to find workers without lifting wages. Higher wages would be passed on as higher prices for customers so more unemployment tends to mean less inflation.

But the jobs market has been surprisingly strong. Health and care sectors have rapidly hired thanks to bigger demand and government subsidies while productivity is going backwards, forcing businesses to hire more workers to keep up production.

The RBA governor, Michele Bullock, has said she wants to see a small increase in jobless rates so there is less pressure from wages on prices, drawing criticism from unions.

Unemployment increasing from 4.6% to 5% would represent an extra 60,000 people out of work if the workforce stayed the same size.

But Bullock said after September’s rate hike that she does not expect job losses, instead hoping job creation will slow and more people will look to join the workforce, leaving jobseekers searching for longer periods.

Markets expect only one more rate rise and not until May 2027. But the Deutsche Bank strategist Lachlan Dynan warns rate rises’ weaker effects add to the risk of another hike.

“The Australian household sector has been more resilient to hikes than many expected,” Dynan says. “Risks to RBA [rates] are back to being skewed to the upside in our view.”