Australia’s Economic Growth Set to Recover in 2025

GDP growth is set to gain momentum despite sticky inflation and high interest rates.

Vanguard expects Australia’s Gross Domestic Product will gradually recover and increase by 2.0% in 2025 after experiencing its slowest growth rate in 32 years during 2024.

This is despite the overhang of sticky inflation and elevated interest rates. Vanguard forecasts that the core Australian inflation rate will fall to 2.5% during 2025, and that the Reserve Bank’s cash rate will be lowered to 3.5% from the current 4.35% level by year end.

This month's Consumer Price Index (CPI) release suggests that inflation is continuing to decline within a jobs market that remains tight.

Yet the underlying inflation rate remains well above the Reserve Bank’s 2%-3% target band, while the unemployment rate of 3.9% is well below the non-accelerating inflation rate of employment (NAIRU) of 4.5%. 

We see limited upside for labour productivity growth in 2025.

“The RBA shouldn’t draw a firm conclusion from the November CPI indicator, in our view,” said Dr Grant Feng, Vanguard Senior Economist. “That said, the RBA will likely stay on hold until the second quarter of 2025, as the last mile of the inflation fight will take longer to conquer.

“We expect a modest sequential improvement in economic momentum, underpinned by rising real household incomes as inflation levels slowly subside, a rebounding housing market, expectations of rate cuts, and structural drivers of public investment.

“Although private demand has weakened in response to the RBA’s monetary policy tightening, public sector demand remains robust, which is a trend that’s likely to continue in the lead-up to the 2025 federal election.

“Moreover, a significant factor contributing to the stickiness of inflation in Australia is stagnant labour productivity growth, which has left the economy still operating near its capacity despite softening demand.”

Dr Feng said that market sectors may face ongoing challenges in 2025 due to low business investment.

“On the other hand, the non-market sector (comprising health care and social assistance, education and training, and public administration and safety) is expanding at a faster pace than the market sector, which shifts employment towards lower-productivity sectors and affects overall productivity performance,” he said.

“Given the ongoing government support for non-market sectors and lukewarm business investment, we see limited upside for labour productivity growth in 2025. This will ensure the labour market remains tight and could put upward pressure on unit labour costs.

“On the external front, a potential U.S. tariff hike is expected to have limited direct impact on Australia, partially offsetting the effects of increased policy stimulus in China.”

Tony Kaye

22 Jan 2025

vanguard.com.au