The market has already begun pricing in a rate cut by the Reserve Bank of Australia (RBA) within months, but UBS's view is significantly more hawkish. UBS believes the current AI investment boom will only push up inflation, and the productivity dividend has not yet materialized. The RBA will maintain a tight monetary policy for a considerable period, with the earliest window for rate cuts not until late 2027 or even 2028. If inflation exceeds expectations again, there is even a possibility of another rate hike at the February policy meeting.

The AI investment boom has initially created a demand shock, but the productivity dividend has yet to materialize.

George Tharenou, chief economist for Australia and New Zealand at UBS, stated that the AI wave is bringing a "price inflation first, efficiency improvement later" pattern to the Australian economy. The central bank estimates that investment in Australian data centers has increased tenfold in the past three years, and the pipeline of approved projects could double that investment again. Theoretically, AI could bring 0.1% to 2% annual productivity gains, but so far, the market has not seen substantial evidence of productivity improvement. In Australia's already tight capacity and high inflation environment, large-scale AI capital expenditure constitutes a positive demand shock, raising the equilibrium neutral interest rate and requiring monetary policy to remain tight for a longer period. Recent remarks by Sarah Hunter, deputy governor of the Reserve Bank of Australia, also confirm that the central bank is paying close attention to the inflationary risks brought by the AI boom and is wary of asset repricing volatility.

The February interest rate meeting carries the risk of a rate hike, significantly deviating from market expectations.

Following the Reserve Bank of Australia's last policy meeting, the market shifted towards a dovish stance, betting on an imminent rate cut, while UBS's baseline scenario was for rates to remain unchanged for an extended period. Taranu stated that in the short term, a rate hike is more likely than a rate cut. If core inflation remains around 1% quarter-on-quarter and inflation data significantly exceeds expectations, the February policy meeting will become a high-risk juncture. Several committee members opposed a rate hike in the last vote, and a very clear signal of higher-than-expected inflation is needed to push for a new round of rate increases. This expectation gap means that if subsequent inflation data rises, Australian short-term bond yields will face upward pressure. For the Australian dollar, a prolonged tightening cycle is beneficial for interest rate differentials, but weak domestic economic growth will limit the Australian dollar's upside potential.

Australia's economic growth is slowing, and the private sector is experiencing near-recession.

UBS predicts Australia's economic growth will slow to 1.4% in 2027, lower than market consensus and slightly below the Reserve Bank of Australia's forecast. AI investment could boost growth by about 0.5 percentage points, and coupled with robust government spending, a technical recession is unlikely in terms of economic scale. However, excluding AI-related investments, private sector growth is near stagnation, declining house prices are suppressing consumer spending, and the unemployment rate will exceed 5%. Taranu also questions official consumer spending data. Official statistics show an annualized growth rate of 6% to 7% in household spending, but listed retail companies' operating announcements show almost no revenue growth. He predicts that official consumer spending data will decline significantly in the coming year, and ordinary residents will feel recession-like pressure, even though macroeconomic statistics do not meet the definition of a recession.

Global growth forecasts are optimistic, but highly dependent on two premises.

Compared to the relatively weak outlook for Australia, UBS holds a more positive view on the global economic trend, forecasting global economic growth of 3.5% in 2027, higher than the market consensus. This optimistic forecast is based on two premises: continued prosperity in the AI industry and a decline in oil prices due to easing tensions in the Middle East. If tensions in the Middle East remain high and oil prices continue to surge, creating an energy shock, both global growth and inflation prospects will be under pressure.

Conclusion

The AI cycle is a core variable in the direction of Australian monetary policy. Short-term capital expenditures are driving up inflation, while the productivity dividend remains a distant prospect, directly prolonging the Reserve Bank of Australia's tightening cycle. The market's previous anticipation of interest rate cuts is at risk of significant correction. The key focus for the Australian dollar and Australian bond markets going forward is the quarterly core inflation data, which will determine whether the February policy meeting will maintain interest rates or resume rate hikes.