The International Monetary Fund is warning the chances of a heavy landing for the global economy have risen sharply, increasing the risks of a deeper slowdown for Australia.
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But, striking a more hopeful note about the medium term outlook, the IMF expects interest rates to decline to pre-pandemic levels once a inflation drops back within target, possibly in 2025.
The fund has forecast world output to expand by less than 3 per cent this year and said it was "plausible" growth could slow to just 2.5 per cent - the slowest pace since 2001.
Disruption in financial markets and the risk of increasing fragmentation of trade and investment has added to the pressure from high interest rates and the effects of the war in Ukraine, the fund said.
Against this backdrop, it expects growth in Australia will slow sharply to just 1.6 per cent this year, causing unemployment to rise. It predicts the jobless rate will reach 4 per cent this year and 4.1 per cent in 2024.
Treasurer Jim Chalmers, who is travelling to Washington DC to attend meetings with the IMF, the World Bank and other G20 finance ministers, said the fund's report confirmed the international outlook was deteriorating.
"Global conditions have become more complex and confronting than they were even a few months ago and Australia is not immune to these challenges," Dr Chalmers said.
"Higher interest rates have exposed vulnerabilities in parts of the international banking system, adding to the challenges of persistent inflation, slowing global growth and the ongoing impacts of the war in Ukraine."
Adding to the worries, inflation has proved stubbornly high despite the significant tightening of monetary policy undertaken by major central banks.
The IMF said its central forecast was that global economy would expand at an annual rate of just 3 per cent for the next five years - the weakest outlook in three decades.
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But it cautioned the chances that growth could be even weaker have increased, not least because of the possibility that recent financial turmoil could intensify and spread.
"Risks to the outlook are heavily skewed to the downside, with the chances of a hard landing having risen sharply," the IMF said.
"In a plausible alternative scenario with further financial sector stress, global growth declines to about 2.5 percent in 2023 - the weakest growth since the global downturn of 2001 [barring the initial COVID-19 crisis and the global financial crisis in 2009]."
The IMF said underlying inflation was proving "sticky" and interest rates may need to rise even higher in order to bring it down.
More optimistically, the fund expects that once inflation comes back within target, probably in 2025, interest rates will return to pre-pandemic levels.
![The International Monetary Fund forecasts the Australian economy to slow. Source: Shutterstock The International Monetary Fund forecasts the Australian economy to slow. Source: Shutterstock](/images/transform/v1/crop/frm/202296158/87ded669-2d84-4670-8182-c6860accf6af.jpg/r0_343_6720_4136_w1200_h678_fmax.jpg)
"Once inflation rates are back to targets, deeper structural drivers will likely reduce interest rates toward their pre-pandemic levels," it said.
The IMF put governments on notice that they needed to support inflation-fighting by adopting an "overall tight stance while providing targeted support".
The government's fiscal stance has been described as broadly neutral but there have been calls for it to do more to reduce demand in the economy.
High commodity prices and low unemployment are expected to deliver the government a revenue windfall and the treasurer has indicated much of that will be directed to the budget bottom line.
Dr Chalmers said the government was "carefully calibrat[ing]" the settings for next month's budget.
"Our focus is on delivering a responsible budget that provides targeted cost-of-living relief without adding to inflation, lays the foundations for future growth and builds our resilience to international shocks," he said.
It is expected to include $1.5 billion of assistance for households to cope with rising energy bills.
But the government is also under pressure to undertake substantial budget repair, including by scaling back the stage three tax cuts and tightening access to tax concessions including for capital gains and negative gearing.