Inflation inches closer to target, but will the RBA cut?

Yesterday’s Consumer Price Index (CPI) release for the December quarter of 2024 indicates inflation is sustainably returning to the Reserve Bank’s target range of 2-3%.

Prices rose 0.2% in the final quarter of the year, which took annual headline inflation to a three-year low of 2.4%. The Reserve Bank’s preferred underlying inflation measure, the trimmed mean, came in at 3.2% over the year to the December quarter, down from an upwardly revised 3.6% in the year to the September quarter. 

Chart 1: Headline and underlying (trimmed mean) inflation

Source: ABS Consumer Price Index

Inflation returning to target, plus the fact that Australia has been in a per capita recession for over a year amid near record-low rates of GDP growth, should open the door for an interest rate cut.

Yet, the surprisingly resilient labour market, elevated government spending, persistent services inflation, and a falling Australian dollar is complicating the Reserve Bank’s decision. 

While the conditions for a rate cut are now real, a cautious Reserve Bank may well hold off until more information on the domestic economy and the rapidly changing global context is available before cutting the cash rate. 

The latest edition of Deloitte Access Economics’ Business Outlook predicts the Reserve Bank will cut the cash rate by a total of 75 basis points through the 2025 calendar year, followed by a further 75 basis points in 2026. By the end of the rate cutting cycle, a household with an average sized mortgage and a variable mortgage rate would be around $8,000 better off in today’s dollars.

The latest edition of Business Outlook also notes that the Australian economy looks as though it may be past the low point for this economic cycle.

The combination of a strong labour market, tax cuts, emerging real wage gains and imminent interest rate cuts is contributing to an improving picture for household spending. At the same time, dwelling construction remains in the doldrums, but appears to no longer be getting worse, and public sector spending is still a key growth driver. 

Those positives set the tone for Deloitte Access Economics’ forecast of accelerating economic growth over the next three years, albeit from a standing start. While the Australian economy is estimated to have grown by only 1.0% in the ‘pandemic hangover’ year of 2024, that is likely to lift to 1.6% in 2025, before picking up to 2.3% and 2.7% in 2026 and 2027, respectively. 

Despite the prospect of a short-term turnaround in growth, the longer-term picture is less malleable. Significant structural challenges weigh on Australia’s economic outlook. A lack of comprehensive economic reform, geopolitical risks and the unaffordability of decent housing suggests there is an opportunity to do better. 

Most notably, Australia’s middling productivity performance is a concern. In real terms, economic output per hour worked has barely shifted over the past decade and has declined since 2020. 

Chart 2: Labour productivity in selected advanced economies

Source: Deloitte Access Economics; International Labour Organisation

At the same time, fewer than 1 million new dwellings are now expected to be completed over the next five years, well below the National Housing Accord target of 1.2 million homes. That means Australia’s housing crisis is likely to last several more years at least.

And while business investment was a key feature of the economic recovery after the pandemic, it has since faded. Businesses reliant on discretionary consumer spending such as those in the hospitality and retail trade industries are particularly impacted by sluggish household spending.

Rapid public sector spending growth has helped to plug the gap left by falling business investment, with government spending forecast to rise to its highest share of the economy since the Second World War. This is coming at the same time as the temporary factors supporting government revenues – population growth, high commodity prices and inflation – are fading. 

These structural spending pressures will support the economic recovery in the near term, though substantive and productivity-enhancing changes to the tax system are needed to ensure government finances are resilient and sustainable over the medium term.

This newsletter was distributed on 30 January 2025. For any questions/comments on this week's newsletter, please contact our authors:

This blog was co-authored by Naasha Kermani, Senior Economist at Deloitte Access Economics

Click on the links below to read our previous Weekly Economic Briefings:

• 2025: global trends are shaping labour markets (23 Jan)
• A preview amid political shifts (17 Jan)
• 2024: A year in review (19 Dec)
• CFO Sentiment: Balancing confidence and caution (12 Dec)