Our economic outlook for Australia

Economic activity has softened since the May meeting of the Reserve Bank of Australia (RBA). Quarterly GDP growth slowed to 0.3% in the first quarter, down from 0.9% in the fourth quarter, with private investment doing much of the heavy lifting, including through data center buildout. Household spending was subdued, suggesting greater consumer caution in response to higher oil prices and the cumulative impact of a higher cash rate. In short, cooling growth momentum should give the RBA some reassurance that the economy is moving toward better balance.

Australia’s supply side remains weak, however, largely reflecting persistent productivity challenges. GDP per hour worked fell by 0.6% quarter over quarter and was up only 0.3% year over year. Annual productivity growth of 0.3% is broadly in line with the average pace of the past decade but remains low by historical standards. The balance between aggregate demand and aggregate supply matters most for the inflation outlook. Even with sluggish productivity growth and limited supply-side momentum, the pullback in demand appears sufficient to guide the economy gradually into balance.

Inflation remains well above target and may rise further in coming months as higher energy prices pass through the broad economy. These persistent inflation pressures argue against any dovish shift in the RBA’s communication. In June, the RBA paused after a series of rate hikes that began in February. But the central bank remains hawkish in its broader policy stance and is likely to retain a tightening bias until clearer evidence emerges that demand is slowing sufficiently to bring inflation sustainably back to target.

The RBA has already tightened financial conditions materially in a short period, and the full effects of that tightening are yet to be felt. Early evidence suggests that higher rates are weighing on domestic demand. The oil-price shock and recent significant tax changes are also contributing to weaker real household purchasing power and softer spending momentum. We continue to expect the RBA to remain on hold for the foreseeable future.