Australian 3Q26 economic outlook: Soft landing, hard choices

Australia enters the third quarter of 2026 in an interesting phase of the cycle: growth has not broken, but inflation has reasserted itself. The economy expanded by only 0.3 per cent in the March quarter, while annual GDP growth was 2.5 per cent; importantly, GDP per capita slipped 0.1 per cent in the quarter, underscoring that headline growth is still being flattered by population and capacity expansion rather than a broad lift in living standards or productivity. 

The central tension for the next 12 months is clear: the Reserve Bank of Australia (RBA) needs demand to cool enough to contain inflation, but not so much that household spending, hiring and investment retreat sharply. Headline CPI inflation eased to 4.0 per cent in May, but trimmed mean inflation rose to 3.6 per cent, which keeps the focus squarely on underlying price pressure rather than headline relief. 

We forecast a soft-landing baseline, but one with a slower disinflation path and limited room for policy relief. GDP growth is expected to ease from 1.9% yoy in 3Q26 to 1.6% in 4Q26, before gradually improving to around 2.0% by late 2027. We believe the economy will absorb higher rates and cost pressures without slipping into recession, but growth is likely to remain below a more dynamic expansion phase. The key implication is that demand conditions are to remain uneven: population growth and essential spending should keep headline activity supported, while discretionary demand stays more sensitive to real income pressures, mortgage costs and confidence. 

Inflation is forecast to decline steadily from 4.0% yoy in 3Q26 to 2.5% by 4Q27, but the path remains slow enough to keep the RBA cautious. With unemployment projected to hold at 4.5% across the forecast horizon and wages growth easing only marginally from 3.2% to 3.1%, the labour market is expected to loosen only gradually, not break. That helps explain why the policy rate remains at 4.35% through late 2026, before easing modestly to 4.10% through most of 2027 and 3.85% by 4Q27. In other words, this is not a rapid easing cycle; it is a controlled recalibration once inflation is clearly moving back toward target. 

For businesses, the message is to avoid waiting for a sharp fall in borrowing costs. Financing conditions should improve only slowly, and investment decisions will need to be justified by resilience, productivity gains or clear demand visibility rather than an assumption of imminent monetary relief. Businesses should plan for modest revenue growth, sharper customer segmentation and continued pressure to defend margins through productivity rather than volume alone.

Business implications

For consumer-facing businesses, demand will be more polarised than the headline data suggest. Essential spending and value-oriented offers should remain resilient, but discretionary categories will need sharper pricing, clearer value propositions and tighter inventory control. The May household spending rebound shows households are still spending, but not with the confidence or breadth that would support indiscriminate price increases. 

Cost pressures will remain the defining boardroom issue. Businesses should assume that inflation falls slowly, not quickly, and that input cost relief will be uneven. Contract management, supplier diversification, energy efficiency and pricing governance should move from finance-team concerns to executive-level priorities.

Hiring decisions should become more selective rather than defensive. The labour market is easing, but unemployment at 4.4 per cent and underemployment at 5.9 per cent do not point to abundant spare capacity. Firms should protect critical capability, slow non-essential recruitment and invest in workforce productivity, especially where wage growth is steady but output per hour is weak. 

Investment strategy should favour projects that reduce unit costs, improve resilience or unlock pricing power. Higher rates make speculative expansion less attractive, but they strengthen the case for digital infrastructure, automation, data capability and process redesign. The winners in this phase will not be the firms waiting for rate cuts; they will be the firms using a slower economy to improve operating leverage before the next demand upswing.

GDP growth outlook

The growth outlook for 2026–27 is best described as modest expansion under a tightening policy canopy. The national accounts show an economy still growing, but the March quarter’s 0.3 per cent rise was soft and reflected subdued household and public sector expenditure, weather-related disruption to mining and exports, and a large import offset from investment in data-centre-related machinery and equipment. This matters for boards because the economy is not collapsing, but the composition of growth is becoming less forgiving: revenue growth will be harder won, and volume growth will be more uneven across sectors. 

Over the next 12–24 months, headline GDP should continue to be supported by population growth, infrastructure needs, business investment in technology and data capacity, and still-positive labour income. But GDP per capita is the more important measure for customer-facing firms. The March quarter decline in GDP per capita suggests that many households are experiencing the economy as a squeeze rather than an expansion. That means aggregate demand can look resilient while individual consumers trade down, delay purchases or become more selective. 

Household consumption remains the swing factor. Monthly household spending rose 1.3 per cent in May after falling in April, and was 5.5 per cent higher over the year, but the ABS noted that part of the monthly rebound reflected reversal effects and travel-related distortions linked to the Middle East conflict. The implication is that spending is not weak enough to take pressure off inflation quickly, but not strong enough to give businesses unlimited pricing power. Upside risks would come from stronger real income growth, tax relief and resilient employment. Downside risks would come from higher energy prices, renewed global uncertainty, softer commodity demand or a sharper pass-through from interest rates to discretionary spending.

Inflation outlook

Inflation is no longer simply a post-pandemic goods problem; it is now a broader cost and capacity-management issue. Headline CPI inflation fell to 4.0 per cent in May from 4.2 per cent in April, but underlying inflation moved the wrong way, with trimmed mean inflation increasing to 3.6 per cent. Housing was the largest annual contributor, rising 6.5 per cent, while food and transport also contributed to annual price growth. 

The key message for businesses is that inflation is past its peak shock phase but not yet back to a benign operating environment. Housing, construction, energy-sensitive transport costs, insurance, financial services and labour-intensive services remain the areas where inflation is likely to prove sticky. Underscoring this, RBA’s June communication was explicit that headline and underlying inflation remain too high, and that some firms facing cost pressures are increasing prices or considering doing so. 

The return to the RBA’s 2–3 per cent target band is likely to be gradual rather than linear. Inflation was already materially above target before the Middle East conflict, and the subsequent lift in energy prices has added another layer of pressure. While tensions now appear to be easing, with a possible US - Iran arrangement under discussion, the terms and durability of any agreement remain uncertain. Until energy markets and shipping routes stabilise more convincingly, Australia is not yet out of the woods on tradable inflation. 

Meanwhile. domestically, the structural element is important: housing shortages, weak productivity and supply-side constraints can keep inflation elevated even if cyclical consumer demand cools. For businesses, this means the next phase of disinflation will rely less on falling goods prices and more on operational discipline, wage productivity alignment and the ability to absorb or pass through costs without damaging demand. 

Labour market

The labour market is easing, but it is not yet loose. The unemployment rate fell to 4.4 per cent in May after rising in April, employment increased by around 40,000 people, and underemployment edged up to 5.9 per cent. Participation remains historically high at around 66.7 per cent, indicating that labour supply is still engaged even as hiring conditions become more mixed. 

For employers, the practical reading is that labour scarcity has eased from its peak but has not disappeared. Wage growth is steady rather than accelerating: the Wage Price Index rose 0.8 per cent in the March quarter and 3.3 per cent over the year. That is manageable for many firms, but the productivity backdrop is less comfortable. GDP per hour worked fell 0.6 per cent in the March quarter and was only 0.3 per cent higher through the year, meaning wages are not the sole cost issue; weak productivity is the real margin problem. 

The turning points to watch are hours worked, vacancies, underemployment and wage settlements. If hours soften while employment holds up, firms may be hoarding labour but reducing utilisation. If underemployment rises further, wage pressure should ease, but consumer confidence may also weaken. If productivity does not improve, businesses will face a difficult choice between higher prices, lower margins or accelerated investment in technology, automation and workforce redesign.

Interest rates and monetary policy

We expect the RBA to stay on a prolonged hold with the data we have at hand as of writing this note. That said, we see a modest upside risk of one further rate hike if the June quarter CPI print, due on 29 July, comes in above expectations.

The Reserve Bank of Australia (RBA) is now in a holding pattern with a tightening bias, not an easing cycle. At its 16 June meeting, the Monetary Policy Board left the cash rate unchanged at 4.35 per cent after three increases since the start of the year, judging that tighter financial conditions were beginning to slow the economy but that inflation remained too high. The RBA’s message was deliberately cautious: leaving rates on hold does not rule out further tightening if inflation expectations or second-round price effects become embedded. 

“Higher for longer” is therefore the dominant near-term policy frame. The RBA is unlikely to ease while trimmed mean inflation remains above target and while energy-related price shocks are still passing through. The May Statement’s baseline was conditioned on market pricing for the cash rate rising towards 4.70 per cent by the end of 2026, although the June pause shows the Board wants to assess lagged effects before moving again. The real challenge for policymakers is managing an economy that is barely gaining momentum, while inflation remains sticky and the labour market only gradually turns.

For households, elevated rates reinforce mortgage stress and discretionary spending restraint. For businesses, they raise hurdle rates, expose weak balance sheets and increase the value of cash-flow visibility. Investment will still proceed where returns are strategic or productivity-enhancing, but marginal expansion projects are likely to be delayed unless demand is proven and financing is secure.

Federal Budget 2026-27 - Fiscal policy

Key Federal Budget measures will take effect from July 2026, led by income tax relief for workers. On the macro front, broadly, this year’s Budget is one of the more responsible ones which we have seen in recent years. It is mildly expansionary without being reckless, there is a clear intent to keep fiscal policy from cutting across the grain of monetary policy, and the cost-of-living measures are sensibly structured.

Tax cuts for workers, healthcare support, fuel excise relief and homeowner provisions all work through the system rather than landing as direct cash handouts, which reduces the inflationary sting. For businesses, the picture is more complicated. There are genuine wins, but also trade-offs and a few measures that sound better than they are.

The biggest risk will be execution and passage. The savings are back-loaded and the productivity agenda depends on state cooperation that has historically been the weak link. If the reforms land as designed, this Budget will age well. If they stall in Parliament or implementation, the spending commitments will outlast the savings meant to fund them.

Key risks to the outlook

The most material risk is inflation persistence. If energy costs, housing costs and services inflation remain sticky, the RBA may need to keep rates higher for longer or tighten further, increasing the probability of a sharper slowdown. This is especially important because the RBA has already warned that higher fuel prices are passing through to broader goods and services prices and that inflation expectations must not become embedded. 

The second-ranked risk is a global shock, particularly around geopolitics, oil supply and commodity markets. Australia is exposed both through direct energy and transport costs and through external demand for commodities and services. The RBA has highlighted that unresolved global oil supply issues could keep pressure on energy prices and inflation while also weighing on trading partner growth.

The third key risk is domestic policy misalignment: fiscal relief supporting demand while monetary policy restrains it, housing policy lifting construction ambition without solving capacity bottlenecks, and migration-driven demand outpacing infrastructure and dwelling supply. 

The fourth is productivity. If output per hour remains weak, Australia risks a lower-growth, higher-cost equilibrium that is difficult for both policymakers and businesses to manage.