The Australian economic landscape revealed a surge in consumption supported continued solid GDP growth in the first half of 2022.

Key issues

  • Inflation is still rising putting pressure on household budgets

  • Limited spare capacity in the labour market

  • RBA has a narrow path as it attempts to slow inflation without causing a recession

Risks to the economic outlook

  • High interest rates slow economic growth more sharply than we anticipate
  • RBA overshoots and raises interest rates too far
  • Persistently higher inflation
  • Uncertain recovery in migration and services exports
  • Population permanently smaller and older post-COVID

Spending resilient despite mounting headwinds

Strong employment growth and the release of pent-up demand from previous COVID lockdowns enabled households to overcome the drag from rising interest rates and the higher cost of living. Consumption rose by 2.2 percent q/q in both Q1 and Q2, well above trend growth. The increase in spending is being driven by a rebound in services, with households continuing to normalise their spending patterns.

Inflation set to peak in the second half of 2022

Oil prices have eased from the highs seen in March and April, but overall energy prices remain high compared to a year ago. The war in Ukraine has also put pressure on food prices globally and those pressures have been exacerbated in Australia due to the floods disrupting agricultural activity. Escalating construction costs and rising housing rents are providing a significant boost to headline inflation. Taken together the headline inflation rate reached 6.1 percent in Q2, and trimmed mean inflation rose to 4.9 percent, the highest rate for each series since 1991.

Labour market tightness stoking wages growth

The labour market remains tight, with robust employment growth taking the participation rate to record highs. There are now roughly as many job vacancies as unemployed people in Australia, and overall the data suggests the economy has reached full employment. Migration should ease severe skill shortages in some specific industries. But, given migration will boost demand for labour as well as supply, the labour market is likely to remain very tight for some time to come.

RBA raising rates rapidly to cool domestic inflation pressures

The rapid rise in inflation and tight labour market has forced the RBA to accelerate its hiking cycle. The cash rate is now at 2.35 percent and Governor Lowe has indicated that further rate hikes will be needed. By mid next year we think the cash rate will have reached a peak of around 3.35 percent.

Full details about Australian economic conditions and forecasts can be found in KPMG's Australian Economic Outlook: Q3 2022