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.
The recovery gains momentum but inflation is uncomfortably high.
You probably know the old joke. A man goes to the doctor and when his test results come back, the doctor tells him, “I have some good news and I have some bad news”.
While it is no joke, the same “good news and bad news” story could be said about the Australian economy. As 2026 kicks off, policy makers are mulling how to lock in the good news whilst simultaneously fixing the areas of bad news.
In broad terms, there has been a solid economic recovery, unemployment is low and household wealth is continuing to grow, which are all part of the good news. Heightened geopolitical conflicts, uncomfortably high inflation, a shortage of housing and intergenerational inequality are the bad parts.
Within those broad themes, there are some particular pluses and minuses which are outlined below.
What the data is saying.
GDP grew 2.6 per cent in the year to the December quarter, which is the strongest GDP result since 2016 (outside the pandemic). This rate of growth is close to the economy’s speed limit, but it means there are good opportunities for business and householders alike as 2026 kicks off.
There is also positive news with a rebound in productivity which is up 1.0 per cent in the past year. Per capita GDP is 2.0 per cent stronger than a year ago. Together, these trends will lead to improvements in living standards.
At the same time, the unemployment rate remains remarkably low at 4.1 per cent. This is just above the lowest level since the early 1970s.
In something of a double-edged sword, house prices are strong, even though there is a wide divergence in price pressures from city to city and in regional areas. Rising house prices are positive for household wealth accumulation but have the obvious downside of making it extremely difficult for first home buyers and upgraders to tap into the market.
Having hiked interest rates in February, the Reserve Bank of Australia has a clear bias to lift rates further, although incoming data on inflation and unemployment will determine the timing and extent of any further rate increases. Global tensions and conflicts could see the RBA delay interest rate changes until there is some clarity about the longer run effects of these issues.
While the next Federal Budget is still some time away (it is due to be handed down by Treasurer Jim Chalmers on 12 May), there is pressure for a wide-ranging economic reform including spending cuts, greater tax efficiency and decisions to deliver a further sustainable increase in Australia’s productivity. The early signs are that there will be steps in the direction of tax reform and spending cuts, although the extent of the progress remains to be seen.
Amid this welcome news, inflation is presenting a challenge for policy makers as it remains well above the mid-point of the RBA 2 to 3 per cent target at 3.8 per cent in headline terms and 3.4 per cent in trimmed mean or underlying terms.
The inflation rate has been skewed higher, in part, by what are called ‘administered prices’. These include the ending of the electricity rebates, excise increases, higher public transport fares and rise in council rates. While these factors are expected to fade through the course of 2026, the RBA is not yet confident that this alone will be sufficient to see underlying inflation return to the middle of the target band in a reasonable time frame.
This is why the RBA has flagged the possibility of further interest rate rises and it’s why money markets are pricing in a peak for the official cash rate of 4.25 per cent, compared with the current 3.85 per cent.
That said, this market pricing can be fickle and subject to sudden and dramatic change. Note that as recently as September 2025, the same money markets were priced for a 3.0 per cent cash rate by the end of 2026, some 125 basis points lower than the pricing in recent weeks.
Housing pressure remains acute.
The housing sector continues to be impacted by the shortage of supply of dwellings relative to on-going strong demand. The key influencers of this supply/demand imbalance remain in place, a point that will have important implications for house prices in the short to medium term.
Disappointingly, the number of new dwelling building approvals remains weak, despite the various government incentives to speed up and simplify the building approvals process.
Over the past year, new building approvals have been running at an annualised rate of 195,000. This is higher than the low in 2023 but remains well below the 240,000 new dwellings per annum needed for the government’s target for 1.2 million new dwellings to be built in the 5 years to the middle of 2029. This is a clear illustration of the lack of supply.
At the same time, demand pressures for housing, particularly from elevated levels of net overseas immigration, remains strong, even though it has moderated from the post-pandemic surge that occurred when the international borders were reopened.
This supply/demand pressure is supporting house prices and at the same time is leading to a low level of dwellings that are available for rent. The rental vacancy rates in most capital cities are at or near record lows. This is fuelling an acceleration in the rate of increase in rents. In addition to the impact of cost of living from this, sharp increases in rent underpins the inflation rate over the more medium term.
What this means for you?
Interest rates are likely to remain relatively high over the next year. This means an official interest rate holding at around 4.0 per cent, which will parlay into mortgage interest rates and terms deposit rates being near or even a little higher than they are today.
For the economy more broadly, solid economic growth will be supportive for the business sector, including profits. The unemployment rate is expected to remain relatively low in a broad 4 to 4.5 per cent range, which is a good economy for job seekers, even with the near certain disruption from the roll out of artificial intelligence in the business sector.
Business investment is rising, which will boost productivity and, with a lag, lower inflation while keeping company profits at a strong level.
House price growth is likely to remain positive, but will moderate especially in the currently strong cities of Perth, Brisbane and Adelaide. The main downside risks to house prices would be a mix of an unexpectedly sharp cut in immigration, a rise in unemployment or blow-back from a global economic shock.
Join us at our Economic Stocktake webinar.
Want a deeper dive into this quarter's stocktake and the chance to ask Stephen your questions? Join us for our upcoming Economic Stocktake webinar on Wednesday 25 March at 6pm ACDT (Adelaide time). Register now to secure your place.
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This is general advice only and has been prepared without taking into account your particular objectives, financial situation and needs. Before making an investment decision based on this information, you should assess your own circumstances or consult a financial planner.
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