Reserve Bank says we'll avoid a recession, but slow grind to bring inflation down

The central bank's latest forecasts show it is increasingly confident that the economy will navigate a narrow path to lower inflation while minimising job losses and avoiding a recession.

It predicts the consumer price index - which rose at an annual rate of 6 per cent in the June quarter - will slow to 4.1 per cent by the end of the year - almost half the level reached in late 2022.

But, highlighting its expectations of an increasingly slow grind in the battle against inflation, the RBA thinks headline CPI will remain above 3 per cent throughout next year before dipping to 2.8 per cent at the end of 2025.

The decline in inflation will be driven by a significant slowdown in the economy, particularly in the second half of this year.

The RBA forecasts gross domestic product to grow by just 0.9 per cent by the end of the year before gradually strengthening to reach 1.6 per cent in December 2024.

But stronger population growth means the country will experience a per capita recession until at least mid-2025.

Slower growth will cause job losses and reduced hiring, which will push the unemployment rate up to 3.9 per cent late this year and it will reach 4.5 per cent in 2025. Wage growth, meanwhile, will top out at 4.1 per cent late this year.

In a phrase that will fuel speculation that interest rates are set for a lengthy pause at 4.1 per cent, the RBA said the risks to the inflation outlook are "broadly balanced".

Markets have begun pricing in the possibility of a rate cut, but not until the second half of 2024.

Commonwealth Bank economists Belinda Allen and Stephen Wu said that although the RBA remained ready to raise rates if needed, "the hurdle to hike again is high".

Speaking before the RBA released its latest forecasts, Treasurer Jim Chalmers said the government expected the economy to "slow considerably" under pressure from high inflation and interest rates and global uncertainty.

"We're seeing inflation moderate in our economy in welcome ways but people are still under pressure," Dr Chalmers said. "Our challenges are substantial."

The treasurer refused to speculate about the future path of interest rates but said the government was committed to "responsible economic management", including cost-of-living relief, a 2022-23 budget surplus, smaller future deficits and investments to lay "the foundations for future growth".

"Our job is to help people through difficult times ... and to lay the foundations for a better future and that's what our economic plan is all about."

There is mounting evidence of the intense financial pressure on households, particularly those with a mortgage or renting.

While rates of loan defaults remain low, mortgage repayments as a proportion of household income have soared to a record high and retail sales by volume have plunged to a three-decade low.

Underlining the impact of high interest rates and rates, Australian Bureau of Statistics figures show actual living costs are outstripping inflation, particularly for those with a job.

The Reserve Bank acknowledged that consumer spending had "slowed considerably" and although the labour market remained tight, conditions there had "eased a little".

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Despite these developments, the central bank warned inflation was likely to persist "for a while, especially for services" because demand continued to exceed supply in parts of the economy, including for rental housing and labour.

In its Statement on Monetary Policy, the RBA admitted that it had considered hiking interest rates at its July and August meetings, but decided that the case for a rates pause was stronger.

It said monetary policy was working to restrain growth and its effects were set to intensify in coming months, and was keen to preserve "as much of the gains in the labour market as possible".

Ms Allen and Mr Wu said the main pressure point for a further rate rise would come if wages grew more quickly than expected.

But they said that by the time the September quarter wage price index was released "the activity side of the economy [will have] cooled enough that another rate hike is off the cards".