Australia’s Inflation Battle Could Lead to Higher Interest Rates

On December 24, 2024, the International Monetary Fund (IMF) issued a warning regarding Australia's economic situation, highlighting that the Reserve Bank of Australia (RBA) may need to increase interest rates. This increase might be necessary if inflation does not continue to decline as expected.

The IMF acknowledged that the RBA’s current restrictive monetary policy is appropriate but emphasized that further tightening might be required should inflation risks become more pronounced. The global financial organization stated, "Inflation is anticipated to sustainably return to the RBA’s target range only by the end of 2025, while a potential stall in disinflation poses a significant risk."

In support of the RBA's efforts, the IMF stressed that a non-expansionary fiscal policy should be implemented to aid in reducing inflation. They recommended that all levels of government consider "expenditure rationalization" to cool down the economy and facilitate a quicker return to target inflation levels.

Treasurer Jim Chalmers expressed that the IMF report reflects positively on the Australian economy. He stated, "Our approach has been to maintain a primary focus on inflation and the cost of living without ignoring the risks to growth, and the IMF supports this strategy."

Despite current challenges, the IMF indicated that Australia is still on track for a soft economic landing, although risks are skewed toward the downside. The economy is projected to rebound slightly from a weak growth rate of 1.2% in 2024 to a modest 2.1% in 2025.

The unemployment rate, currently low at 3.9%, is expected to gradually rise to around 4.5%. Should economic growth turn out to be weaker than expected or if unemployment increases more rapidly, the RBA might consider cutting interest rates sooner, according to the IMF.

The RBA is anticipated to begin reducing interest rates in early 2025. Following a recent meeting where the cash rate was maintained at 4.35%, market analysts believe a reduction could occur as soon as February 2025. Traders are optimistic, indicating almost a three-quarters chance of a 25 basis point cut.

Analysts have suggested that the meeting minutes from December’s session could reinforce a dovish outlook regarding future financial conditions. IG markets analyst Tony Sycamore noted, "The meeting minutes will likely sound dovish in line with the statement and be watched for more details around scenarios in which future financial conditions might need to be less restrictive."

In the retail sector, business leaders are predicting a slight increase in sales during the holiday season. Australian Retailers Association chief industry affairs officer Fleur Brown emphasized the importance of interest rates to consumer confidence, stating, "Interest rates are everything when it comes to consumer confidence. That’s critically important for many small businesses in particular, who’ve really just been hanging in there by a thread."

Looking ahead, the IMF recommended that Australian governments pursue broader tax and expenditure reforms to address budget deficits and enhance economic efficiency. Proposed measures include phasing out the capital gains tax discount and decreasing reliance on direct taxes such as the personal income tax.

The IMF also urged a focus on revitalizing Australia’s productivity growth, advocating for better competition policies, expanded opportunities in artificial intelligence, and increased research and development efforts. Dr. Chalmers noted, "The IMF has endorsed our efforts to make our economy more competitive, dynamic and productive, like our historic shake-up to Australia’s merger settings."

inflation, interest, economy