In this last economic report for 2024 we turn our attention to what we think may happen in 2025 and 2026. In a nutshell we forecast that Australian economic growth will accelerate from an average annual average of 1.1% estimated for 2024 to 2.3% in 2025 with average annual CPI inflation falling from 3.3% in 2024 to 2.9% in 2025 ahead of an acceleration above 3.5% in 2026. If our forecasts are close to the mark, the RBA could deliver small cash rate cuts from mid-2025, perhaps 75 bps in total to 3.60%, but the cuts will be short-lived with the RBA starting to lift the cash rate again late in 2026 or in early 2027.
Helping to underpin our 2025 Australian economic forecasts we see economic growth running above trend in the US and firming in China – assisted by stimulus measures turning more towards priming consumer spending. European economic growth is also likely to improve on the back of both more government spending and easier monetary conditions.
What detrimental impact on growth internationally arises from President-elect Trump’s promises of higher tariffs is a story for 2026 and beyond. 2025, for the global economy, is more about the lagged impact of the easing monetary conditions that began in 2024 as well as the impact on real wage growth in 2025 of persistently tight labour markets throughout 2024. The turn to real wage growth or stronger real wage growth through 2024 is likely to continue in 2025 and is likely to support firm consumer spending in 2025 almost everywhere.
The impact of the turn to real wage growth priming stronger consumer spending we think will become clearer in 2025 in Australia as well. Around the world, labour market conditions have stayed tighter for longer than would be expected normally in the face of less robust economic growth. In part a post-covid shift in consumer spending patterns in favour of labour-intensive services accounts for why labour markets have stayed tight for longer.
Australia is experiencing unusually tight labour market conditions given that consumer spending and economic growth have been very soft this year so far.
The November labour force report showed another big increase in employment, up 35,600 with the unemployment rate falling to 3.9% from 4.1% in October. The growth in employment has been mostly in the public sector and is catch up in previously under-staffed areas – education, health services, emergency services. That catch-up still has some way to go and will continue in 2025. Also, much less robust growth in private sector employment may take a turn stronger in 2025 if growth in consumer spending and economic growth accelerate as we expect in 2025.
In short, it is unlikely in our view that tight labour market conditions will become easier in 2025. That is why we forecast that the unemployment rate will be 3.8% at the end of 2025 (RBA forecast 4.5%) from probably 3.9% (RBA forecast 4.3%) at the end of 2024. In turn, annual wage growth at 3.5% y-o-y in Q3 2024, rather than continuing to fall as the RBA is forecasting will rise a little and become sticky. We forecast annual wage growth at 3.8% y-o-y at both the end of 2024 and the end of 2025 (RBA’s forecasts respectively 3.4% y-o-y and 3.2%).
Our stronger labour market and wage growth forecasts, compared to those that the RBA published in the November Monetary Policy Statement, mean that inflation is likely to be higher and stickier than the RBA is forecasting. Like the RBA we see headline annual CPI inflation falling to around 2.5% y-o-y in Q2 2025, but then bouncing without the benefit of electricity rebates to 3.5% y-o-y in Q4 2025 and holding at that rate or higher in 2026.
Falling annual inflation in the first half of 2025 provides the leeway for the RBA to start cutting the cash rate probably in May. The forces generating the bigger and stickier bounce in inflation from stronger household consumption and GDP growth; continuing tight labour market; and sticky wage growth are unlikely to be evident fully until August/ September with the releases of Q2 2025 wages and GDP. That is when the RBA’s rate cuts are likely to stop in our view. Perhaps three 25bps rate cuts at the three interest rate setting meetings between May and August 2025 and then a pause with the cash rate at 3.60%.
During the closing months of 2025 we forecast the pause in the cash rate at 3.60% may extend for several months until it becomes clearer that the labour market is staying tight and that the push up in inflation above 3.5% y-o-y in late-2025 may extend in 2026 rather than fade as the RBA is forecasting currently.
In 2026 with inflation above 3.5% y-o-y on our forecasts, our forecast cash rate at 3.60% becomes flat to negative in real terms and too stimulatory for the economy with inflation stuck above the RBA’s 2-3% target band. It then becomes a question of timing when the RBA starts to hike the cash rate. We pencil in Q4 2026 as the start of the new rate hiking cycle.
We present our view of what could happen in 2025 and 2026 as a credible alternative to the more common view that persistently soft Australian economic growth drives up unemployment and pushes down wage growth and inflation over the next two years allowing the RBA to cut the cash rate earlier and by more. The relative strength or otherwise of data reports over the next few months will determine which view is closer to the mark.
This is the last economic report for 2024. Wishing our readers a safe and happy holiday season and a prosperous New Year. The first economic report in 2025 will be published on Monday 13th January.