Our economic outlook for Australia

Weak productivity remains the economy’s key supply-side constraint. Although real GDP growth remained resilient in the second quarter at 2.1% year over year, labor productivity declined by 0.2%. This suggests that Australia’s potential growth rate may have weakened, contributing to an acceleration in the growth of unit labor costs. The combination of a tight labor market and subdued productivity growth is sustaining domestic cost pressures. As a result, the economy’s disinflationary impulse does not yet appear strong enough to return inflation to the 2%–3% target set by the Reserve Bank of Australia (RBA).

Elevated inflation remains the RBA’s overriding concern. Despite falling housing prices, trimmed mean consumer price inflation remained elevated in the second quarter at 3.6% year over year. Higher oil prices leave near-term inflation risks clearly skewed to the upside, while AI-related data-center investment is adding a further source of demand and capacity pressure.

More fundamentally, the Australian economy continues to operate beyond its sustainable capacity, with unemployment remaining low by historical standards. Against this backdrop, there is a material risk that above-target inflation becomes embedded in wage- and price-setting behavior. Preventing such an outcome is arguably a more pressing challenge for the RBA than for many other major central banks.

Our base case is that the RBA pauses for the remainder of the year as it assesses the effects of its latest rate hike, to 4.6%, in September. This outlook is contingent on clearer evidence that demand is slowing, labor market conditions are easing, and underlying inflation is moving sustainably lower. If the economy proves more resilient than expected, or if higher energy prices generate broader and more persistent inflationary pressure, the risk of an additional rate increase will remain firmly on the table.