Inflation spooks Australian markets as the economy picks up some momentum

2025 ended with a major recasting of economic conditions in Australia.

GDP has recovered, inflation has unexpectedly picked up, business investment is strong and the unemployment rate remains low. These dynamics have seen a reversal of interest rate pricing with rate hikes starting to be priced in from the second half of 2026, rather than further cuts that were priced in several months ago.

The housing market is strong, with house prices rising rapidly and new dwelling building approvals generally higher.

The balance of updated economic news is good for business.

Global economic conditions remain tepid, with moderate or slowing growth in the major economies. There remains a general bias from G7 central banks to trim interest rates in response to the economic softening. In a sign that points to a return to lower inflation in 2026, the broad measures of global commodity prices have been flat to lower, especially when gold and silver are excluded.

Australia

GDP growth lifted 0.4 per cent in the September quarter for an annual rise of 2.1 per cent. The annual rise in GDP was the strongest in two years and above the recent forecasts from the RBA. Drivers of this better growth performance were household consumption, business investment and dwelling construction. There was slower growth in public demand as governments steadily repair fiscal settings.

Inflation has picked up in recent months, with the headline CPI rising 3.8 per cent in the year to October, while the trimmed mean or underlying rate increased 3.3 per cent, both above the top end of the RBA 2-3 per cent target band. There is some debate on whether this inflation lift is a reliable reflection of prices pressures in the economy. This is because ‘administered prices’, those driven more by government actions on electricity subsidies, excise on tobacco and alcohol, public transport fares and the like, rather than market determined prices, remain well contained.

In a sign that inflation may not be as worrying as the headline figures suggest, wages growth remains consistent with the RBA target. The wage price index rose 3.4 per cent in the year to the September quarter, while private sector wages growth eased to a three year low of 3.2 per cent.

While the labour market has softened since the end of 2024, the extent of the rise in unemployment has been moderate. After several months of weaker job creation, employment rose 42,000 in October which was strong enough to see the unemployment rate tick lower from 4.5 per cent to 4.3 per cent.

The Federal government will reveal an update on the budget in the Mid Year Economic and Fiscal Outlook during mid-December.

The story on house prices remains one where strong increases continued through to November based on strong demand, low supply and more favourable household financial conditions. While the RBA does not target house prices with its interest rate settings, it does take account of the wealth effect for households and with house prices rising, additional growth in consumer spending is likely into 2026.

New Zealand

The RBNZ continues to react to the problematic domestic economic conditions with a further interest rate cut. With the economic recovery still fragile and the unemployment rate increasing to 5.3 per cent in the September quarter, the RBNZ cut the cash rate by 25 basis points in November to a post-pandemic low of 2.25 per cent. There have now been 325 basis points of cuts in this cycle, which contrasts with just 75 points of cuts from the RBA.

Key data are pointing to some recovery but at this stage, growth remains patchy. Consumer demand and the housing sector remain the key elements of a sustained recovery.

The outlook remains uncertain although with a substantial amount of monetary policy stimulus now in place, there is growing optimism about the medium term outlook.

Currencies

Currency markets remain remarkably stable, despite the global trade issues and divergence in economic performance across countries.

As has been the case in recent months, the AUD continues to trade in a range of 65 to 66 US cents while the NZD has been broadly stable around 58 US cents. As a result, the AUD NZD cross remains around 1.1450, having moved from around 1.0900 in the middle of the year when it was clear the New Zealand economy was entering a recession and while Australia was more resilient.