Already restrictive financial conditions in Australia are expected to tighten even more, which will weigh on demand and possibly stop the Reserve Bank of Australia (RBA) from hiking interest rates any further despite inflation remaining above target, BofA Securities said in a Wednesday note.

Rising real interest rates, declining home prices, tighter credit availability, and a hawkish US Federal Reserve should together lead to a slowing of domestic demand growth, according to the investment banking firm.

"We expect the RBA will remain on hold through 2026 with a clear tightening bias, while assessing whether the combination of higher real rates, slowing demand, and an easing labor market is sufficient to return inflation to target," BofA Securities said.

Real interest rates are poised to increase through the remainder of this year and 2027 as inflation expectations ease, even under BofA's base case scenario of no further rate hikes, reinforcing the drag on consumption and investment.

Meanwhile, a more hawkish US Fed will exert upward pressure on Australian yields, raising funding costs across the curve and tightening conditions independently of the RBA's policy, BofA Securities said. It added that softer house prices and lower turnover are expected to spill over to weaker consumption, construction, and broader activity.