Stephen Koukoulas, Zagga’s Economist-in-Residence, says recent economic developments continue to support the Reserve Bank of Australia’s decision to leave interest rates unchanged.
While inflation remains above target, a range of indicators suggest the economy has softened more than previously expected. Household spending has weakened, unemployment has risen and the latest inflation data came in below the Reserve Bank’s forecasts.
A softer economy supports the pause
According to Stephen, “unemployment being higher than expected, inflation being lower than expected, well that leads to the on hold decision” to keep the cash rate at 4.35%.
The current policy setting appears sufficiently restrictive to slow economic activity and bring inflation back towards the midpoint of the Reserve Bank’s target range over time.
As economic growth moderates, unemployment is expected to rise further, potentially approaching 4.8% to 5% if current trends continue.
Inflation trending in the right direction
Although inflation remains too high, recent data suggest it is moving in a more favourable direction.
Stephen highlighted that the Reserve Bank’s current forecasts imply inflation could fall below the midpoint of its target range within the next 18 months if interest rate settings remain unchanged.
While forecasts are always subject to change, the broad trend currently points towards easing inflation pressures.
Housing prices continue to decline
Housing remains one of the most closely watched parts of the economy.
Stephen noted that house prices are now declining across much of the country. Earlier weakness was concentrated in Sydney, Melbourne and Canberra, but softer conditions are spreading to other cities.
At present, the declines remain relatively modest. Sydney and Melbourne are approximately 5% below their peak levels, while other markets have only recently moved into negative territory.
Stephen expects the nationwide peak-to-trough decline in house prices to be around 7% to 9%, a range consistent with previous downturns.
Importantly, he does not view current conditions as a housing market crash.
The supply challenge remains
One consequence of falling house prices may be slower housing construction.
If developers become concerned that future sale prices will be lower than current expectations, some projects may be postponed. This could further restrict the delivery of new housing supply at a time when affordability and availability remain significant challenges.
Stephen noted that this creates a potentially counterproductive dynamic where falling prices can discourage new development, ultimately limiting future housing supply.
Demand factors are still supporting the market
Despite softer prices, several factors continue to support housing demand.
Migration levels remain relatively elevated, wage growth continues, and first home buyers are benefiting from improved affordability conditions following recent price declines.
Stephen also highlighted the role of the government’s 5% deposit scheme, which may be encouraging more first home buyers to enter the market.
At the same time, some investors appear to be reducing their exposure to housing due to recent tax changes.
Looking ahead
For now, Stephen’s assessment is that the economy is slowing, inflation has likely peaked, unemployment is trending higher and house prices may have further downside over the short to medium term.
Looking further ahead, he believes 2027 could present a more challenging economic environment, with weaker growth and higher unemployment raising important questions about the future direction of monetary policy.
As he summarised:
“The door is open, let’s say, that the next move in rates is down.”
While Stephen is not yet forecasting a rate cut, he believes the next move in interest rates remains evenly balanced and will depend largely on the future path of inflation.
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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.
