The economy is a patchwork of highs and lows; house prices fall, resilient economic growth, interest rate hikes, rising unemployment while inflation stays high.
The June quarter GDP confirmed a step down in growth from a peak of 2.6 per cent at the end of 2025 to 2.1 per cent. Slower growth is a central theme of the tightening in economic policy in 2026 as a means to lower the inflation rate. It is yet to fully play out.
Household spending growth is easing, dwelling construction has taken a turn lower while business investment is strengthening and expectations are for a continued expansion in FY2026-27.
Inflation remains problematic rising to 4.0 per cent in August, while the trimmed mean rate has been steady at 3.6 per cent for the past four months, a pace still around 1 percentage point above the RBA target.
Helping the outlook for inflation, at least to a point, is moderate wage growth. The annual wage price index rose by 3.2 per cent in the June quarter to be consistent with the RBA inflation target. The labour market is softening with the unemployment rate increasing to 4.6 per cent in August. After several years of shortages, the labour market is showing signs of slack.
Falls in house prices are now evident across the country. The weakness is most marked in Sydney where prices are down over 8 per cent from their peak, with a similar fall in Melbourne. Previous ‘boom’ cities for house prices, Perth, Brisbane and Adelaide, are now experiencing price falls along with Canberra and Hobart.
Key data
Below is an update of key trends in the economy:
GDP rose 0.4 per cent in the June quarter to be 2.1 per cent higher than a year earlier. The composition of that growth was favourable with business investment expanding 10.5 per cent in annual terms, there was a lift in dwelling investment, household consumption grew and there was a fall in the contribution to GDP from public sector demand. For the first time in three years, net exports added to economic growth
Household spending stalled in August after three months of strength. Sales of EVs and petrol remain volatile and generally supportive of growth – most other areas of household spending are slowing in line with weak consumer sentiment, falling wealth and declining real wages growth.
The unemployment rate rose to a fresh 5 year high of 4.6 per cent in August, even though employment growth remained positive. Aside from the monthly volatility in the monthly data, it is now clear that the labour market is weakening in line with the slowing economy. The unemployment rate is tracking above the latest RBA forecasts.
Inflation jumped in August, rising 4.0 per cent in annual terms with rising petrol prices, tobacco and electricity prices adding the bulk of the increase. The trimmed mean inflation rate was steady at 3.6 per cent, remaining well above the RBA inflation target. Other ‘underlying’ measures of inflation remain around 3.5 per cent.
Business conditions turned negative in August, the first such reading since the pandemic. Expectations for sales and profits weakened. Cost pressures remained elevated which was a factor keeping business confidence negative. High oil prices, tight interest rates and slowing economic growth are all impacting the business sector.
In a similar trend to that experienced by the business sector, consumer sentiment has resumed its weakness after what now appears to be a temporary recovery around the middle of the year. Petrol, interest rates, cost of living, rising unemployment and falling house prices are impacting sentiment in a negative way.
The number of new dwelling building approvals fell 6.1 per cent in August confirming a ‘topping out’ in activity. This points to a turning point lower in dwelling construction after an encouraging pick up in the prior 18 months. Falling house prices and rising building costs are impacting the construction market more broadly. Any material downturn in building approvals will see the shortage of dwellings persist which, perversely, will put a floor under the house price falls.
RBA monetary policy and the current market pricing for the cash rate
The RBA hiked interest rates by 25 basis points at its 29 September meeting, delivering the fourth rate hike in 2026, a move which took the cash rate to a 15 year high of 4.60 per cent. In hiking rates, the RBA noted on-going high inflation, high oil prices and resilient domestic economic growth as the reasons behind the decision. Dampening this hawkishness was an acknowledgment from that falling house prices and the rising unemployment rate were issues presenting a possible downside risk to the medium term economic outlook.
After the latest hike, markets are now pricing in a high probability of a final 25 basis point hike in late 2026 / early 2027 with a possibile hike after that. The inflation and unemployment data in coming months will determine whether this pricing is correct.
The inflation problem being seen in Australia is evident globally. Most major central banks are hiking interest rates is response although most are not hiking to the extent of the RBA.
House prices
House prices have been falling for five consecutive months, with prices down in all capital cities. Rising unemployment, tighter credit, a moderate rise in dwelling supply and a fall in demand are all impacting, as are the series of tax changes announced in the May budget.
The peak-to-current level shows a nation-wide cumulative 5 per cent decline, with the largest price falls in Sydney (down 8 per cent) and Melbourne (down 7 per cent) and the bulk of the other cities down between 3 and 4 per cent.
Context is important when looking at house prices – the 5 and 10 year history of house prices show the current pull-back is modest after the huge gains over that timeframe. That said, if house price falls extend for a further year or the declines exceed 10 per cent, there are likely to be macroeconomic consequences including weaker household spending and a decline in new construction.
That said, it remains unclear how long and how deep the house price declines will be. There have been seven periods since the 1980s where prices have registered falls. On average, prices fell by between 6 and 8 per cent, reach a trough after 12 to 18 months with the ‘losses’ recouped within a year of the trough passing.
Stephen Koukoulas is Managing Director of Market Economics, having had 30 years as an economist in government, banking, financial markets and policy formulation. Stephen was Senior Economic Advisor to Prime Minister, Julia Gillard, worked in the Commonwealth Treasury and was the global head of economic research and strategy for TD Securities in London.
