Staff from the International Monetary Fund have indicated that underlying inflation pressures in Australia remain stubborn, and there is considerable uncertainty over whether current financial conditions are tight enough. As a result, the Reserve Bank of Australia should maintain a tightening bias and be prepared to raise interest rates further if necessary. The institution projects that inflation will stay elevated through 2026 before gradually returning to the 2% to 3% target range.

Keep Rate Hike Option on the Table

Following the conclusion of the 2026 Article IV consultation, IMF staff stated that controlling inflation should remain the top priority for Australia's near-term economic policy. With persistent underlying price pressures, the RBA needs to keep a tightening stance and decide on further hikes based on incoming data. The institution noted that after the RBA lowered rates in 2025 due to easing inflation and rising employment risks, the move to re-tighten monetary policy entering 2026 was appropriate, given that domestic demand outperformed expectations and energy price shocks pushed prices higher.

The report also cautioned that if global energy prices surge again significantly and spill over into other goods and services, inflation expectations could rise, potentially requiring additional tightening measures from the RBA. Conversely, if economic growth were to decline sharply, rate cuts could be reconsidered, but only on the condition that underlying inflation continues to fall and upside price risks diminish considerably.

Underlying Inflation Remains Above Target

The RBA held the cash rate target steady at 4.35% in August. The central bank stated that inflation re-accelerated in the second half of 2025, with subsequent data suggesting some price pressures stem from insufficient economic capacity and strong demand. Australia's consumer price index rose 3.5% year-on-year in July, down from 3.8% in June. However, the trimmed mean inflation rate, which tracks underlying price trends, remained at 3.6%, unchanged from June and still above the RBA's 2% to 3% target band.

Housing, food, and recreation and culture services were the main contributors to annual inflation. Housing prices rose 5% year-on-year, new dwelling prices increased 5.7%, and rents climbed 3.6%. Automotive fuel prices jumped 7.5% month-on-month in July, indicating that energy prices could still cause short-term price volatility.

Economic Growth Expected to Gradually Slow

IMF staff project that Australia's real GDP growth will decelerate to 1.9% in 2026 and further to 1.6% in 2027, under the influence of tighter monetary and financial conditions. The report assessed that employment, household spending, business investment, and public infrastructure construction remain resilient. If household consumption and corporate investment continue to outperform expectations, economic growth could receive support, but inflation may also stay elevated for a longer period.

Beyond monetary policy, the institution recommended that the Australian federal and state governments gradually tighten fiscal policy. Over the past two fiscal years, increased spending on infrastructure, healthcare, and the National Disability Insurance Scheme has widened the aggregate fiscal deficit. Slowing the pace of government expenditure growth could ease demand pressures and complement the RBA's efforts to bring inflation back down.