Our economic outlook for Australia

Australia’s economy is proving more resilient than expected. Real GDP grew by 0.4% in the second quarter and 2.1% year over year, exceeding market expectations and forecasts of the Reserve Bank of Australia (RBA). Household consumption continued to be a key source of strength, rising by 0.4% in the quarter, supported by solid income growth and accumulated savings. The softening housing market has yet to produce a meaningful negative wealth effect, while resilient household demand continues to support employment in labor-intensive service sectors.

A growing concern is that demand is strengthening while the economy’s supply capacity weakens. GDP per hour worked was flat in the quarter and fell by 0.2% year over year, suggesting that Australia’s already-low potential growth rate may have declined further. With productivity failing to improve, even moderate demand growth could place renewed pressure on labor costs, capacity, and prices. The economy may therefore be growing above its current “speed limit,” making a sustained return of inflation to target more difficult.

The July Consumer Price Index (CPI) report reinforced this concern. Trimmed mean inflation rose by a stronger-than-expected 0.5% in the month and remained at 3.6% year over year. Inflation pressures were broad-based, with a growing share of the CPI basket recording price increases above a 3% annualized pace.

Taken together, stronger demand, declining productivity, and broad-based inflation leave the RBA with little margin for error. Although the full effects of earlier tightening are still working through the economy, the latest data challenge the view that current policy settings are sufficiently restrictive to return inflation sustainably to target. We now expect one more RBA rate hike this year, which would take the cash rate to 4.6%.