In this quarterly report the Australian Fixed Income team provide a concise domestic economic, credit and currency outlook for Q1 2026.
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Policy Overview
The RBA held the cash rate steady at 3.60%1 throughout Q4 25, but shifted to a more hawkish stance in December, noting that inflation risks remain persistent. Inflation reaccelerated, with headline CPI rising to 3.8% YoY in October2 and core measures trending higher. The RBA expressed concern about price pressures, particularly in housing and services. That said, the RBA noted uncertainties from the new (monthly) data series and was therefore inclined to wait for more evidence of persistent pressure before increasing rates. A February 2026 rate hike is now considered a live possibility by the market3, with major banks forecasting one to two hikes in H1 2026.
Macroeconomic Overview
Australia’s economy continued to grow in the December 2025 quarter at a modest trend-like pace (GDP growth of 0.4% qoq/ 2.1% yoy4). Private investment grew 2.9%, contributing 0.5ppt to GDP growth, the highest rate of quarterly growth seen since March quarter 20215. Private demand led the expansion, with private investment boosted by a surge in machinery & equipment spending (+7.6% QoQ) tied to data centre construction. The rise in gross disposable income (1.7% qoq) outpaced the rise in nominal household spending of 1.4%, leaving scope for additional spending.
Meanwhile, business conditions surveys in Q4 remain broadly supportive, with NAB’s index of business conditions hitting +10 in October (the highest since early 2024) before falling slightly to +7. Businesses have started to markup capex plans, showing an intent to expand capacity with a greater degree of confidence.
After easing through mid-2025, inflation pressures picked up again in Q4 2025. The new full monthly CPI data showed headline inflation rising from 3.6% YoY in September to 3.8% in October – moving further above the RBA’s 2–3% target band. Core inflation is also running high: the October trimmed mean CPI rose +0.3% MoM, lifting its annual rate to 3.3% (up from 3.0% in September). This indicates that underlying price growth remains elevated and sticky. One volatile component – electricity prices – fell sharply in October (-10.2% MoM) due to the rollout of government rebates in NSW and ACT. Even so, power prices remained +37% YoY. The RBA’s November Statement on Monetary Policy significantly revised its inflation outlook upwards – it now projects headline CPI around 3.7% by mid-2026 before a late-year easing.
The trend unemployment rate reversed its sharp increase from the previous month falling from 4.4% to 4.3%6 as the participation rate remained unchanged at 66.8%. That said, the unemployment rate remains relatively low and is slightly above the recent low seen in 2022. Wage growth held at 3.4% YoY7, with the RBA expecting this to ease a little over 20268. Companies are managing to hire enough to keep unemployment low, but not so much as to create a surplus of workers.
Bond Yields
Australian government bond yields increased across the curve, driven by a change in monetary policy expectations and global rate dynamics. The 3-year yield rose over 50 basis points to around 4.1%, reflecting market repricing as the RBA’s hawkish pivot in December signaled a potential rate hike in early 2026. Longer-dated yields, including the 10-year and 30-year benchmarks, remained elevated, with the 10-year yield increasing to end the quarter near 4.8% (+44bps) and the 30-year yield at 5.2% (+23bps). These movements were influenced by persistent inflation data, strong domestic demand, and global investor caution around long-term fiscal positions. Looking ahead, bond yields are expected to remain elevated, with front-end rates sensitive to upcoming RBA decisions and inflation prints, while long-end yields may stabilise if global risk sentiment improves and inflation expectations moderate.
Credit
Credit spreads remained stable and relatively tight, supported by strong fundamentals and healthy issuance conditions. Offshore investors continued to show interest in Australian credit, attracted by higher spreads to government bonds compared to markets like the US, although the cross-currency pickup has moderated since mid-year. For those seeking additional yield, stepping down the capital structure into subordinated instruments can provide a reasonable yield pickup. Credit quality remains fundamentally sound, though the Reserve Bank of Australia’s policy outlook and ongoing inflation risks introduce uncertainty—especially for rate-sensitive sectors like real estate investment trusts (REITs), airports, and retail.
Currency
The Australian dollar (AUD) traded within a relatively narrow range during the December 2025 quarter, hovering in the mid-0.65s against the US dollar. The RBA’s hawkish shift in December helped stabilize the AUD, as markets began pricing in a potential rate hike in early 2026. Looking ahead, the AUD may find upward momentum if the RBA tightens policy while the Fed continues easing, narrowing interest rate differentials. However, downside risks remain if domestic inflation proves more persistent than expected, limiting the RBA’s flexibility.
Overall
We remain cautiously positive on the fixed income outlook in Australia. We anticipate total returns to be driven mainly by interest income with current elevated yields providing a good entry point, and potentially some capital gains if yields drift lower. While risks (global shocks, inflation surprises) persist, current valuations provide a reasonable buffer. As of Q4 2025, Australian fixed income offers an appealing mix of income, quality, and defensive characteristics, making it a valuable component of a diversified portfolio.
Recent Market Data
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▲ QoQ GDP grew 0.4%, with the annual rate lifting to 2.1% YoY
GDP for Q2 2025 was revised 20bps higher to 2.0%, indicating the economy has been operating at trend for two consecutive quarters. The shift from public‑led to private‑led growth continued, with household consumption rising (0.5% QoQ, 2.5% YoY) and contributing 0.3ppt, while private investment (3.2% QoQ, 3.7% YoY) added 0.5ppt, driven mainly by machinery and equipment linked to data‑centre build‑outs. Public spending was also firm, with public consumption up 0.8% QoQ adding 0.2ppt, and public investment rising 3.0% QoQ contributing 0.2ppt. Offsetting GDP were inventories (-0.5ppt), largely from mining, and net exports (-0.1ppt) as import growth (+1.5%) slightly outpaced exports (+1.9%).
Source: ABS, Bloomberg, BlackRock as of 2/1/2026
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▼ Conditions fell MoM by 3pts from +10pts to +7pts
▼ Confidence fell MoM by 5pts from 6pts to +1ptIn November, business conditions fell 3pts to +7 index points, as falls in profitability (9>4), and trading (18>15) were marginally offset by an improvement in employment (3>4). Business confidence fell from 6pts to +1 index points unwinding much of the gains over the last 6-months. By industry, trend confidence was strongest in manufacturing, while wholesale and mining were in negative territory. Capacity utilisation measures remained elevated and above long run average levels at 83.6%, an 18-month high. This is largely focused in two industries construction and recreation & personal services. Forward orders softened marginally from 3 to 1 index point.
Source: NAB, Bloomberg, BlackRock as of 2/1/2026
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▼ The Westpac-M.I. Index of Consumer Sentiment fell 9%
MoM from 103.8 in November to 94.5 in December.Consumer sentiment is back in the ‘cautiously pessimistic’ territory after a surprising bounce in November which resulted in the first ‘net positive’ reading since reopening from the pandemic. The sub-indices showed views on economic outlook and family finances deteriorating. The ‘family finances vs a year ago’ sub-index fell 5% to 80.9. and the ‘family finances next 12mths’ sub index also fell 6.1% to 102.4, though still remained in slightly positive territory. Concerns about the economic outlook prevailed with the ‘economic outlook, next 12 months’ and the ‘economic outlook, next 5 years’ sub-indices both falling in December and below 100, indicating more pessimism than optimism. The ‘time to buy a major item’ index declined 11.4% to 98.9, reversing last month’s optimism.
Source: Westpac, Bloomberg, BlackRock as of 2/1/2026
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▲ Headline CPI increased by 1.3% QoQ
▲ Annual inflation rose from 2.1% to 3.2%A closely watched measure of core inflation, the trimmed mean, also rose by 1.0% with the annual rate rising from 2.7% to 3.0%. The monthly CPI rose to 3.8% in October. Electricity prices continue to be a source of volatility with prices falling by -10.2% on the month, although remain +37.1% higher over the year. Headline and trimmed measures of inflation should rise into 2026 due to unfavorable base effects and electricity subsidies unwinding. Housing component inflation which has been a material source of disinflation over the last 2-years has troughed. Inflation is likely to remain outside of the target band for the next few quarters.
Source: ABS, Bloomberg, BlackRock as of 2/1/2026
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▼ Number of jobs saw a fall of -21.3k.
▶ Seasonally adj. unemployment rate remained steady at 4.3%.The Australian labour force survey showed that employment fell by -21.3k in November following a 41.1k rise in the previous month. The unemployment rate remained unchanged at 4.3% owing to a large drop in the participation rate from 67% to 66.7%. Hours worked is 1.2% higher over the last year in line with employment growth of +1.3% YoY. However, 6mth-annualised employment growth has slowed to 0.8%. Broader measures of the labour market such as the underemployment rate spiked from 5.7% to 6.2%, albeit flat compared to levels from a year ago and tight by historical levels. Leading indicators suggest a stabilization ahead. The labour market has been gradually easing, although remains tight.
Source: ABS, Bloomberg, BlackRock as of 2/1/2026
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▲ Wages increased by 0.8% over Q3
▶ Annual wage growth remained steady at 3.4% YoYPrivate sector wages grew by 0.7% QoQ and 3.2% YoY, while public sector wages continued to outpace them for a third consecutive quarter, rising 0.9% QoQ and 3.8% YoY. Public sector wage growth remained elevated, largely due to the contribution from state government, which accounted for 82% of the increase. By pay method, award wages were strong, supported by the 3.5% increase in minimum wages effective from 1st July. The RBA expect wages growth to moderate to 3.0% over the next year which will be necessary due to slower productivity (now assumed to be 0.7% p.a.) for inflation to return to target.
Source: ABS, Bloomberg, BlackRock as of 2/1/2026
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▶ The RBA left the cash rate unchanged at 3.60% which was a unanimous decision and in line with market expectations
The RBA board felt that it was appropriate to remain cautious updating its view of the outlook as the data evolves. The board moved in a more hawkish direction as they felt that the risks to inflation were to the upside rather than previously. The RBA expressed most concern around the inflation outlook and were uncertain as to how much inflation was due to temporary factors as opposed to a broadening of inflation and the prospect of persistence. The RBA’s view on the labour market remained unchanged stating that it remained a little tight despite the modest easing in the unemployment rate and slowing in employment growth.
Source: RBA, Bloomberg, BlackRock as of 2/1/2026
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▲ The Cotality national HVI rose 1.0% in November
▲ The Cotality national HVI increased 7.1% over the yearGrowth in Australian capital-city dwelling prices was again strong increasing at 1.0% MoM in November albeit slightly slower than Octobers 1.1% increase. Capital city prices are 7.1% higher over the last year. Auction clearance rates have eased after peaking in mid-September foreshadowing a possible slowing of house price appreciation as affordability is hitting a record high of 8.2% (median dwelling value to pre tax household income). Private sector credit grew at 0.7% MoM and 7.3% YoY in October. Business credit growth remains a key driver (+9.3% YoY), however housing growth (+6.5% YoY) remains buoyant. Building approvals fell -6.4% in October after a 11.1% increase in September. The decline was driven by a -13.1% decline in the volatile apartments category.
Source: Cotality, BlackRock as of 2/1/2026
