The Reserve Bank of Australia faces a critical decision next month as it determines its interest rate policy amid a slowing economy and rising unemployment. In June, the economy grew at its weakest non-pandemic pace since the early 1990s, with annual GDP growth at just 1.1 percent. The unemployment rate has risen from a near 50-year low of 3.5 percent in mid-2023 to 4.1 percent, with the number of unemployed people increasing by 117,000 since October 2022.
This sharp decline in economic performance suggests that unemployment could continue to rise in the coming months. While the RBA predicted in May that the unemployment rate would peak at 4.3 percent, this now seems overly optimistic. In comparison, the US has seen a similar rise in unemployment from 3.5 percent to 4.1 percent over the past year, but its GDP growth has been more resilient at around 2.5 to 3 percent.
The key difference between the US and Australia is in their interest rate expectations.
Interest rates and rising unemployment
The US anticipates a series of interest rate cuts starting in September, while Australia still expects potential rate hikes in the coming months before a moderate easing by the end of 2025.
Many market participants have pointed to the local June quarter inflation data, due on July 31, as a potential trigger for a rate hike. However, given the weak economy and rising unemployment, the RBA is likely to revise its inflation forecasts for 2025 and 2026 lower. Even if inflation meets or exceeds expectations, the RBA’s dual mandate to maintain full employment and a 2 to 3 percent inflation rate will likely persuade them to hold rates steady.
A rate hike in the face of a struggling economy and rising unemployment could be seen as a major policy error. The realistic economic outlook includes weak growth, continued rising unemployment towards 5 percent, and wages growth easing to 3 to 3.25 percent. This would likely secure inflation within the 2 to 3 percent target range by the next quarter.
Based on these projections, it appears that the next move in interest rates will be down, reflecting the need to support the economy rather than tightening financial conditions further.
