The economy is slowing but not by much. While high interest rates and a tightening in fiscal policy are impacting confidence and the labour market, economic growth is resilient.
The checklist of news on the economy makes for interesting analysis. Household spending growth is strong and getting stronger, dwelling construction remains positive and business investment in data centres, warehouses and in AI and technology related parts of the economy are offsetting the weakness elsewhere.
That said, falls in house prices are now evident across the country. The weakness is most marked in Sydney where prices are down over 6 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.
While inflation is falling, the deceleration is not as rapid as the RBA would like to see. Annual inflation fell to 3.5 per cent July but the trimmed mean inflation rate is more resilient, remaining steady at 3.6 per cent. Both measures are still too high and above the RBA’s ultimate target for inflation of 2.5 per cent. The inflation result has seen markets price in a high probability of a 25 basis point rate hike before year end and possibly as soon as September.
Helping the outlook for inflation is moderate wage growth. The wage price index rose by 3.2 per cent in the year to the June quarter to be a growth pace that is consistent with the RBA inflation target.
The labour market is softening with the unemployment rate increasing to 4.5 per cent in July, up from 4.1 per cent at the start of 2026 and what was a cyclical low of 3.5 per cent in 2023. After several years of labour shortages and tight condition, the labour market is starting to show signs of slack.
The next meeting of the RBA Monetary Policy Board is 29 September.
Key data
Below is an update of key trends in the economy:
- Household spending rose a solid 1.1 per cent in July with the result following monthly gains of 1 per cent or more in the prior two months. In annual terms, spending rose by a hefty 7.0 per cent, the sharpest annual increase in three years. The figures sit at stark contrast to consumer sentiment and anecdotes from the business sector about activity in their businesses.
- Employment fell 17,000 in July, but this followed an increase of 80,000 in June. While the monthly data remain volatile, the trend remains towards a slowing in job creation and a more acute weakness in hours worked. The unemployment rate ticked up to 4.5 per cent in July, to be holding around 0.5 percentage points higher than a year ago and a full percentage point above the cyclical low in 2022.
- The wage price index rose 0.8 per cent in the June quarter which was the fifth straight quarter of an 0.8 per cent rise. Annual wages growth was steady at 3.2 per cent. Wages growth has slowed from a peak over 4 per cent. The current pace of wage increases is consistent with the RBA’s 2 to 3 per cent inflation target.
- Inflation eased in July, with the annual rate at 3.5 per cent, down from a peak of 4.6 per cent in March. The trimmed mean inflation rate was steady at 3.6 per cent having broadly held that pace since the March quarter. Other measures of underlying inflation are picking up and inflation remains above the RBA target range, is a concern for it and markets. While the outlook is for inflation to fall, it may be too slow for the RBA’s liking and as such, markets are pricing in a possible rate hike by year end with a further hike possible in early 2027.
- Private sector business investment fell 3.6 per cent in the June quarter, but this followed strong increases of 6.9 per cent in the March quarter, 0.9 per cent in the December quarter and 6.5 per cent in the September quarter. Investment rose 10 per cent over the year confirming that the broad trend in business investment remains solidly positive. It was also good news in that business expected investment for FY2026-27 was a very strong 15 per cent higher than for the same survey last year a result that would be good news for bottom line GDP growth and future productivity.
- In March, after a sharp fall in reaction to the US bombing of Iran and the associated spike in oil prices, business confidence has recovered somewhat but remains negative. Business conditions, which is the better proxy for actual economic activity, has stabilised in recent months and remains mildly positive. Business conditions are consistent with an overall pace of moderate growth.
- In a similar trend to that experienced by the business sector, consumer sentiment fell sharply in March and April but has since started a recovery. A partial reversal of the petrol price spike and steady interest rates since May appear to the be the main positives for consumers. In aggregate, sentiment remains negative with falling house prices impacting wealth and there are ongoing pressures with cost of living.
- In trend terms, the number of new dwelling building approvals continues to rise. In June, they reached a four year high. Approvals rose 7 per cent in June to be 40 per cent higher than the cyclical low in 2023. New housing activity is a central policy aim of the government as it strives to add to dwelling supply as a fundamental issue improving housing affordability.
RBA monetary policy and the current market pricing for the cash rate
Economic resilience and ongoing inflation outcomes have reinforced market pricing for the possibility of higher official interest rates in the short to medium term. Not only is an interest rate hike priced in by end 2026, but there is a slight chance incorporated into markets for a further hike into 2027.
Internationally, there continue to be a series of interest rate increases but these are by no means universal and tend to be slow to be delivered by the relevant central banks. That said, futures markets are pricing in a gentle interest rate hiking profile in most major economies.
House prices
The falls in house prices are now broadly based, led by Sydney and Melbourne which are down by more than 6 per cent from their respective peaks. Prices are falling in all cities as the effect of rising unemployment, cost of living pressures, a pick up in supply and a cooling in housing demand all kick in. All of these pressures are negative.
The tax policy changes announced in the Budget in May are also having an impact, with sharp falls in lending for investors for established dwellings. This has been partly offset by a strong jump in lending for newly built dwellings, which are still be eligible for negative gearing.
It remains unclear how long and how deep the current price falls will last. The usual cycle for falling house prices is 9 to 18 months, with overall peak to trough falls on 7 to 9 per cent. So far, the current cycle is now 5 months old and prices have fallen by around 3.5 per cent.
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.
