Australian SMEs have been hit with an interest rate hike for the first time in more than two years after the Reserve Bank raised the cash rate by 0.25 per cent to 3.85 per cent. 

The widely-predicted move follows an uptick in inflation data that caught many off guard last month. For Australian SME owners, it’s a double squeeze where rising debt costs collide with a cooling in household spending. Employment Hero CEO Ben Thompson said these dual factors meant the rate rise was not a surprise. ”Higher rates will add pressure for households and small businesses at the same time as the labour market is already starting to cool,” he explained.

The Reasons Behind The Rate Hike

The decision was driven by data showing that the RBA’s previous efforts haven’t yet brought inflation comfortably back to its target range. Headline inflation hit 3.8 per cent in the December quarter, sitting stubbornly above the 2-3 per cent target band, reflecting what the bank referred to as ‘capacity pressures.’

“Growth in private demand has strengthened substantially more than expected, driven by both household spending and investment,” the bank’s Monetary Policy Board said in a statement. “Activity and prices in the housing market are also continuing to pick up. Credit is readily available to both households and businesses.” Its prediction: “Inflation is likely to remain above target for some time.”

Commonwealth Bank Chief Economist Luke Yeaman said the RBA was operating under a concept of asymmetric risk, effectively prioritising the fight against entrenched, long-term inflation over the marginal cost that a single hike might impose on the broader economy, including small businesses. For the RBA, the risk of letting inflation run away was far greater than the risk of cooling the economy too quickly, he said.

Employment Was A Key Factor In The Rates Decision

Another factor in the RBA’s decision was employment, describing the labour market as ‘a little tight.’

While unemployment fell to 4.1 per cent in December, Ben Thompson said data from 350,000 employers suggested fragility. “The latest Employment Hero jobs data shows hiring is slowing and employers are cutting hours. That’s most pronounced amongst younger Australians and in casual, shift-based roles – jobs that depend on rostered hours, weekend shifts and seasonal demand,” he said. “While the rise is clearly intended to curb inflation, we’d expect that cooling trend to become more evident in our data as business owners navigate a tougher environment.” 

Business Response: The Structural Squeeze & Lobby Group Outcry

For SMEs, interest rate rises are a blunt instrument that hits both top-line revenue and bottom-line stability. Because many small business owners rely on variable-rate loans or use residential equity to fund their operations, higher repayments eat directly into cash reserves that could otherwise be used for inventory, marketing or maintenance. This pressure often ripples through the supply chain as larger partners pass on their own increased borrowing costs, further inflating the general cost of doing business for SMEs.

On the revenue side, higher mortgage repayments drain the disposable income of Australian households, reducing consumer spending power, particularly on discretionary items like entertainment and hospitality. This creates a difficult environment where SMEs are facing higher monthly repayments at the exact moment their customers are pulling back.

The financial strain is already reflected in borrowing and insolvency data. The Banjo Barometer shows 2025 ended with a 5 per cent dip in SME lending demand, with the Manufacturing (-38 per cent) and Transport (-39 per cent) sectors leading the retreat. Meanwhile, Coface Australia has warned that a 25 basis points increase could push up business failure rates in 2026 from 0.5 per cent to 4-5 per cent.

More broadly, industry lobby groups are now demanding the Federal Government shift focus from monetary to fiscal policy. In its Pre-Budget Submission, the Australian Chamber of Commerce and Industry called for Budget repair to halt inflation, including a cap on government spending at 25 per cent of GDP. This sentiment was echoed by Ai Group’s 2026 Outlook, which found that leaders were bogged down by regulatory and tax burdens that hampered their ability to absorb these rising costs. Treasurer Jim Chalmers told Parliament, “We’re doing what we can to strengthen the budget and address our longstanding productivity challenge.” 

The RBA says it will pay close attention to the global economy and financial markets before announcing its next rates decision on March 17.