Having slowed this year amid tight monetary conditions and worsening terms of trade, GDP growth is projected to pick up to 1.9% in 2025 and 2.5% in 2026. The unemployment rate, which has risen but remains low, is projected to flatten out just above current levels. While headline inflation has now fallen to within the 2-3% target range, core inflation remains somewhat higher. Unexpectedly stubborn services inflation could delay or forestall the projected easing of monetary policy, while an abrupt slowing of immigration would hinder consumption growth. As a small open economy, Australia is also exposed to the risk of an increase in global trade restrictions.

An easing of monetary policy is warranted over the next year given ongoing disinflation and below-potential growth. Strong public spending growth is currently helping to offset weak private consumption, but a degree of budgetary consolidation will be needed in the coming years to ensure that future fiscal pressures can be addressed. Fostering an adaptable labour force will be key to coping with the climate, ageing and digital transitions. Policymakers should beware, in seeking to curb immigration to ease pressures on housing costs, of worsening labour shortages, including in house-building.

GDP growth was below 1% (annualised rate) from the fourth quarter of 2023 through to the second quarter of 2024 and most high-frequency indicators of activity – including PMIs, leading indicators and business sentiment – point to continued weakness in the second half of 2024. Robust government spending growth has kept GDP growth positive as tight monetary conditions restrained private consumption and investment. Inflation, which peaked in late 2022, has continued to fall – the headline rate in August 2024 was within the central bank’s 2-3% target range for the first time in three years, and it fell further to 2.1% in September – although continued upward pressure remains on housing costs in particular. The unemployment rate, which in mid-2023 was at its lowest level in nearly 50 years, has moved back up, and vacancies have fallen, but the ratio of vacancies to unemployed persons remains well above its pre-pandemic level. The government’s latest Skills Priority List (for 2023) assessed that 36% of occupations were in shortage, with construction and health among the sectors where shortages were most acute.

Weak external demand for Australia’s key commodity exports has resulted in falling export prices and stagnating volumes over the past 18 months, exerting a drag on output and corporate profits. A surge of immigration coming out of the pandemic yielded average annual labour force growth of 3.4% between mid-2020 and the third quarter of 2024. This was initially more than matched by employment growth, boosted by strong commodity prices, buoyant export growth and initially accommodative monetary conditions.

Monetary policy remains restrictive – indeed, with inflation falling and nominal policy rates unchanged since November 2023, real interest rates have been rising – but with headline and core inflation projected to be back below target by early 2025, a gradual easing of policy is expected to begin next year and to continue into early 2026, taking the policy rate down to 3.35%. Fiscal policy is currently moderately expansionary, with the federal budget balance projected to worsen by two percentage points of GDP between the 2023/24 and the 2025/26 fiscal years. The loosening of fiscal policy this year largely reflects cost-of-living support from the federal government, mainly via income tax cuts and extended energy payment assistance. Some states are also providing further energy payment support this year. Government plans indicate that fiscal consolidation will begin in the 2026/27 fiscal year. In calendar year terms, the fiscal stance is moderately expansionary in 2024 and 2025, with a small tightening in 2026 – the stance is broadly neutral over 2025‑26.

Growth is expected to improve from the second half of 2024 onward, given strengthening real wage growth, fiscal stimulus, and a projected reduction of interest rates in 2025. One risk is that if inflation declines more slowly than expected, whether because of persistent cost pressures in services or because of new commodity price shocks, interest rates may stay higher for longer than projected, further squeezing demand. Another risk is that an abrupt fall in immigration could both undermine consumption growth and add to labour shortages in some sectors, aggravating bottlenecks. With exports accounting for more than a quarter of GDP, Australia is exposed to a shift to more restrictive trade policies in major trading partners. Australia is particularly vulnerable to weakness in China’s economy, although this is a two-sided risk as Chinese policy stimulus could boost Australian exports by more than expected.

The widening of the fiscal deficit this year has helped sustain domestic demand in the context of weak private consumption and investment, but a degree of consolidation is warranted in the medium term given the ageing-related fiscal pressures on the horizon and the benefits of maintaining fiscal buffers. An easing of monetary policy should be possible in the coming quarters but may have to be slowed if services inflation remains elevated or if external developments result in further depreciation of the Australian dollar and upward pressure on goods prices. Over the longer term, in the context of population ageing, climate change and digitalisation, it will be increasingly important to promote an adaptable labour force, with skills well suited to emerging needs. Immigration policies have a role to play in this, while also easing labour shortages in key areas such as construction.