Economic Stocktake.

Stephen Koukoulas is one of Australia’s leading economic visionaries, past Chief Economist of Citibank and Senior Economic Advisor to a former Prime Minister of Australia. Here is his economic update for this quarter.

Is the next move in interest rates down? 

At many levels, the last three months have seen mixed news on the economy. 

A highlight was the decision of the Reserve Bank to not only hold official interest rates steady at its June meeting, but to signal that the current level of rates is appropriate to see inflation trend lower. Encouragingly, the current view of the RBA is that inflation is still on track to decelerate towards its 2 to 3 per cent target, in line with its most recent forecasts from May. 

While the RBA did not explicitly give any guidance about the future path for official interest rates, it said it will hike again only if inflation is higher than currently forecast. 

Important offsets included the RBA noting tentative signs of a resolution to the US-Iran conflict and, with that, lower oil prices. It also noted the recent news of a higher-than-forecast unemployment rate and falls in house prices in some cities, a trend that is gathering breadth and momentum. If unemployment continues to edge up and house prices fall further, it will help to contain inflation. 

Money markets have moved in line with these economic themes. Markets are close to pricing out any further interest rate rises, and pricing towards rate cuts is emerging for 2027 and 2028. 

Good and bad news in the economic data.

In terms of key data, the good news was confirmation that economic growth was solid. Annual GDP growth was a decent 2.5 per cent in the March quarter, even though quarterly growth slowed to 0.3 per cent. The GDP data confirmed a recovery from the low point of 0.8 per cent annual GDP growth in 2024 but was not so strong as to spark fears of higher inflation. 

There were ongoing concerns, with inflation remaining high at 4.2 per cent in headline terms and 3.4 per cent in underlying terms. This remains well above the target of the RBA but was as expected. That said, there are clear signs that economic growth is slowing into the June quarter – household spending is weakening, the export sector is slowing, and growth in government demand is being scaled back, in part due to significant cuts to growth in NDIS spending. 

Consumer sentiment and business confidence have fallen sharply in response to earlier RBA rate hikes and the oil shock, but with the oil price falling, a partial recovery is expected in the months ahead. 

In other signs of a slowdown in the economy, the unemployment rate rose to 4.5 per cent in April, a four-and-a-half-year high. Furthermore, house prices are continuing to weaken to the point where outright price falls are being recorded in Sydney, Melbourne and Canberra. 

The Federal Government handed down the budget on 12 May, with much of the focus on the reforms to capital gains tax and negative gearing. These are part of a strategy from the Government to tighten the budget bottom line and inject greater fairness into the tax system. That said, there has been vocal pushback from parts of the business sector due to the additional tax that is likely to be paid when the new rules fully come into effect. 

The budget is forecast to remain in deficit in each of the next four years of the forward estimates, but at around 1 per cent of GDP, those deficits are small and manageable. 

The US-Iran war and its impact on the oil market remain a wild card, but recent news of a probable end to the conflict has seen oil prices fall sharply. This will be a critical factor in helping inflation globally and in Australia fall back to acceptable levels. 

Housing – the stars are aligning for house price weakness.

The housing sector is navigating a period of solid construction activity, falling prices, and policy changes that are likely to impact negatively on investors and positively on first home buyers. 

The weakness in house prices is emerging as a critical issue for the economy. House prices are a key driver of changes in household wealth, consumer sentiment, household spending, and the health of the banking sector. 

According to data from Cotality, house prices are falling in Sydney, Melbourne and Canberra, while the rate of increase is slowing in all other capital cities. A combination of rising unemployment, a pick-up in supply, slower demand and constraints on borrowing following the 2026 interest rate hikes are working to dampen prices. 

From peak levels, house prices are down by around 3 per cent in both Sydney and Melbourne and are 1 per cent lower in Canberra. 

Given that the factors putting downward pressure on house prices are set to remain in play for the medium term, further price weakness is likely, and it is set to extend to other cities. 

At a national level, an orderly pullback in prices of 5 to 7 per cent over a 12-to-18-month period is a likely scenario, with more significant falls, or a ‘crash’, unlikely. 

A ‘crash’ in house prices is unlikely for several reasons. 

Demand for dwellings will remain positive, with net migration continuing at around 225,000 to 250,000 people a year. There is also a natural increase of 125,000 per annum, which adds to demand. 

This, together with a possible interest rate cutting cycle, will put a floor under prices. Rising construction costs for both materials and labour will support house prices, as developers and builders need to cover costs to add to new dwelling supply. 

The recent tax changes are likely to have broadly offsetting effects on house prices. With investors set to significantly reduce demand as they shy away from purchases of established dwellings (which no longer qualify for negative gearing), a key underpinning of prices has been removed. 

Offsetting this, at least to some extent, is a likely lift in first home buyer activity. First home buyers are being buoyed by the softening in house prices, as well as generous schemes in terms of grants, subsidised mortgage insurance and other government incentives. 

What this might mean for you.

Interest rates are at, or very close to, a peak. There have been falls in government bond yields over the past month, which are often a leading indicator of future changes in official rates. It is important to note that any interest rate cutting cycle will occur later rather than sooner. The RBA needs to be convinced that inflation is firmly on target before cutting. 

This is where ongoing trends in global oil prices; the unemployment rate and inflation will determine when the RBA will be inclined to move to cut rates. 

The weakness in house prices might be attractive for opportunistic purchasers. While investors will now be encouraged, by the revised tax laws, to invest in newly constructed dwellings, first home buyers will benefit from improved affordability. 

Periods of flat or weak house prices can be a good time for those ‘upsizing’ their house to act. While the price of the current property may be slightly disappointing, the price paid for the ‘better’ or upsized property will be more within reach.