Rate hike 'risks hurting' fragile consumer sentiment

Waning consumer confidence could give the Reserve Bank pause as it mulls hiking interest rates at its next meeting.

Household spending data released by the Australian Bureau of Statistics on Monday showed consumers were gathering steam late last year.

Spending through the year to November surged to 6.3 per cent - the highest annual pace in more than two years.

But consumer sentiment figures, released by Westpac and the Melbourne Institute on Tuesday, provided a more timely view of the mood of Australian households.

And the results don't make for encouraging reading.

After a sharp nine point fall in the index in December, consumer sentiment fell another 1.7 per cent to 92.9 in January.

"While confidence is still well above the extreme lows recorded during the protracted 'cost of living' crisis in 2022? 2024, consumers are becoming more concerned about what 2026 may bring for family finances and the wider economy," said Westpac's Matthew Hassan.

The main catalyst for this has been a sharp turnaround in interest rate expectations since late October, Mr Hassan said.

Money markets now predict at least one hike this year, following a recent resurgence in inflation, with traders pricing in about a one-third chance of a hike in February.

The strong spending result increased the likelihood of inflation bouncing back from its recent fall to 3.4 per cent, VanEck head of investments and capital markets Russel Chesler said.

"Inflation remains elevated, and between government energy rebates rolling off, higher tariffs flowing through to consumer prices, and geopolitical conflicts impacting major supply chains - not to mention the stickiness of services and housing inflation - keeping it on a tight leash this year will not be straightforward," he said.

"Which means that it is likely that the RBA will need to increase the cash rate this year."

But AMP economist My Bui said the fall in consumer sentiment showed the recent uptick in inflation was unlikely to be sustained.

Heavy discounting and stronger household finances have driven spending activity, but fragile confidence readings raise the prospect of weaker spending outcomes in December and January, she said.

"With inflation still too high for the RBA liking, we think that the RBA will retain a hiking bias but remain on hold in the February meeting, as a rate hike will risk hurting the private household and business sectors which have just started the recovery in 2025," Ms Bui said.

"The prospects of higher rates have already dampened households' sentiment and will rein consumer spending in the upcoming months."

The fall in confidence was mainly driven by forward-looking components, such as expectations of family finances and economic conditions 12 months from now, NAB senior associate economist Jessie Cameron said.

Responses about current financial conditions actually improved over the month.

NAB's chief executive Andrew Irvine said he remained optimistic about the prospects for Australia's economy this year.

He said finding ways to boost productivity would be essential to growing the economy.

"Backed by strong employment, the economy continues to do well, and we don't expect more stimulus or another rate cut right now," Mr Irvine said.

"The question for the Reserve Bank is going to be: does it need to put a little bit of a handbrake on that growth?

"The challenge is that we don't have any excess capacity."