Our economic outlook for Australia

Australia entered the current energy shock with inflation already above target, which is a key difference from other developed markets. After reaching a trough in mid‑2025, core inflation reaccelerated as growth outpaced potential and capacity constraints persisted, exacerbated by weak productivity.

The first-quarter CPI print in 2026 showed trimmed mean inflation at 3.5% year over year, still well above target. With energy prices set to rise further in the second quarter, near‑term inflation risks clearly skew to the upside. Importantly, the economy has been running beyond sustainable capacity, with the unemployment rate below estimates of full employment. This raises the risk that elevated inflation becomes embedded in expectations, which is arguably a more pressing concern than in other major economies.

Historically a laggard in the global rate cycle, the Reserve Bank of Australia (RBA) appears to be pivoting toward a more proactive stance. Three consecutive hikes (in February, March, and May) suggest a shift from follower to first mover. While sentiment indicators have deteriorated, the RBA appears increasingly focused on its price‑stability mandate. The priority is clear: prevent inflation from becoming entrenched and avoid a repeat of 2022, when inflation materially overshot the RBA’s target.

Meanwhile, Australia’s policy environment has shifted meaningfully. The strong support seen in 2025, including rate cuts, fiscal expansion, and tax relief, is reversing. In 2026, tighter monetary policy, a fading fiscal impulse, and rising energy costs are combining to create a materially less supportive macro backdrop. This reinforces our more cautious view on the domestic outlook relative to consensus.

Whether the RBA tightens further will hinge on how quickly the economy weakens. The combination of higher rates and rising fuel costs has already triggered a sharp deterioration in sentiment, suggesting a downturn may be underway. Our base case is that the RBA pauses to year-end, contingent on clearer evidence of slowing demand and labor market softening. However, if the economy proves more resilient than expected, the risk of an additional hike remains firmly on the table.