AUD/USD 2026 Outlook: Monetary Policy Divergence and USD Trend Reversal

The outlook for Australian monetary policy has shifted decisively over the past quarter. What began as a broad market consensus for a final rate cut, followed by a prolonged hold into 2026, has been replaced by renewed concern around inflation persistence.

Stronger-than-expected CPI and GDP prints, combined with a still-resilient labour market, have forced the RBA into a hawkish hold stance. Markets have now fully priced out further easing, implying the tightening cycle may already have concluded after just three cuts, leaving the cash rate at 3.60%.

With inflation pressures resurfacing, attention has turned to whether the next policy move is higher rather than lower. The upcoming quarterly CPI release has become the key catalyst, with markets increasingly sensitive to any upside surprise.

Australia’s Q4 CPI: The Key Policy Trigger

Australia’s Q4 CPI data is shaping up as the decisive input for the RBA’s next move. Underlying inflation measures remain uncomfortably close to the upper bound of the central bank’s 2 to 3 percent target range, with trimmed mean inflation already elevated.

A stronger-than-expected CPI print would significantly increase the likelihood of a 25bp rate hike as early as February. Such an outcome would reinforce the RBA’s long-held warnings around upside inflation risks, which appeared premature earlier in 2025 but have since been largely validated.

The December meeting delivered a hawkish hold, with the Board explicitly acknowledging that inflation risks have returned. While an immediate hike was not considered, policymakers outlined the conditions under which further tightening would be justified. Decisions are now firmly data-dependent, with the January CPI release acting as a clear inflection point.

That said, the RBA is unlikely to embark on an aggressive tightening cycle. Unemployment has been trending gradually higher over the past two years, and continued softening in labour market conditions would limit the scope for multiple hikes. Under this scenario, a single hike could see the cash rate peak near 3.85%, followed by an extended hold through the second half of 2026.

Australia takeaway: Inflation may rise temporarily and trigger a single 25bp hike in early 2026, but easing labour market conditions should cap rates below 4% and reduce the need for further tightening later in the year.

Federal Reserve Outlook: Rate Cuts, Politics, and the Dollar

The Federal Reserve delivered a widely anticipated 25bp cut at its December meeting, marking the third consecutive easing move. However, internal divisions within the FOMC have clouded the outlook, with the dot plot projecting only one additional cut in 2026.

As with the RBA, labour market data will be the key determinant of policy direction. A gradual rise in unemployment would be disinflationary and provide the Fed with room to deliver two or more rate cuts. This would also align with ongoing political pressure from President Trump, who has consistently advocated for lower interest rates.

However, monetary policy in 2026 is unlikely to be driven by data alone. As midterm elections approach, the administration is expected to prioritise growth-supportive policies while maintaining public pressure on the Fed. Stronger growth, however, risks reigniting inflation, complicating the central bank’s easing path.

A further political dimension emerges in May 2026, when Jerome Powell’s term as Fed Chair expires. Trump is widely expected to appoint a more dovish successor, increasing the probability of a structurally easier policy stance beyond mid-2026.

A low-probability but high-impact risk remains a legal challenge to the US tariff regime. Any ruling against the tariffs could trigger a sharp risk-off reaction, weighing heavily on risk-sensitive currencies such as the Australian dollar. While unlikely, the potential impact warrants monitoring.

US takeaway: A gradual deteriration in the US labour market would open the door to at least two rate cuts in 2026, with the risk of additional easing if growth slows more sharply. Political pressure and potential leadership changes add further downside risk to the US dollar.

US Dollar Index (DXY): Technical Outlook

The base case for 2026 is a bearish year for the US dollar. Weaker employment trends, slowing growth, and the prospect of a more dovish Fed leadership point toward sustained downside pressure.

From a structural perspective, the rally from the 2011 low to the 2022 high appears impulsive, while subsequent price action suggests the dollar has already peaked. The advance from mid-2023 into early 2025 shows clear corrective characteristics, with overlapping price swings and limited follow-through.

Momentum studies suggest the recent rebound remains weak. While a final push toward the 102 area cannot be ruled out, the broader risk is skewed toward renewed weakness through 2026.

The dollar index’s average annual range over the past decade sits near 14%. If upside remains capped below 102, a similar range would imply downside potential toward the low 90s, with deeper declines possible in a more pronounced economic slowdown.

AUD/USD Outlook Summary

A stabilising to mildly hawkish RBA, combined with a softening US dollar backdrop, creates a constructive environment for AUD/USD in 2026. While near-term volatility remains tied to CPI outcomes and global risk sentiment, policy divergence increasingly favours the Australian dollar over the medium term.

Bottom line:Limited upside for US rates, growing downside risks for the dollar, and a resilient RBA stance support a bullish bias for AUD/USD into 2026, with pullbacks likely to remain corrective rather than trend-changing.