Leading indicators suggest the Australian economy is growing at a pace marginally below our estimate of trend, or its non-inflationary growth potential. Demand has weakened in response to restrictive Reserve Bank of Australia (RBA) monetary policy, but the economy’s supply side has also been constrained, with lackluster productivity growth keeping inflationary pressures elevated.

The pace of year-over-year headline inflation rose in the second quarter for the first time since the quarter ended December 2022, to 3.8%. The pace of trimmed mean inflation—a measure of core inflation that excludes items at the extremes—slowed modestly, to 3.9% on an annual basis. Given low productivity growth and, as a result, higher unit labor costs, we don’t foresee headline or core inflation falling to the midpoint of the RBA’s 2%–3% target range until 2025.

Emphasizing that it will be “some time yet before inflation is sustainably in the target range,” the RBA on August 6 left its policy rate unchanged at 4.35%. Returning inflation to target is its highest priority, the RBA said in its monetary policy statement. Vanguard expects the RBA to remain on hold for the rest of the year before beginning a gradual easing cycle amid an anticipated weakening in both inflation and the labor market.

An elevated employment-to-population ratio suggests a still-tight labor market. We expect the unemployment rate to rise from its current 4.2% to around 4.6% this year as financial conditions tighten amid elevated interest rates.