The Australian Economic Outlook Becomes More Challenging

Key Points:

• Higher interest rates and fuel prices are expected to weigh on economic growth in the second half of the year. Furthermore, strong global investment in AI continues to support growth, while a likely near-term easing of Middle East tensions would reduce downside risks.
• The RBA Monetary Policy Board has signalled a pause to its interest rate rises in June, while it monitors the impact of previous rate rises, inflation trends and global developments.
• The AUD has strengthened against the USD over the past year. Provided there is a reasonably quick resolution to the Middle East conflict, the prospects of continued mild appreciation are favourable.

Key influences impacting the economic outlook
There continues to be significant and competing forces impacting the Australian economic outlook. Higher fuel prices and increased interest rates are expected to be a drag on economic growth in the second half of the year. At the same time, economies around the world, particularly the US, continue to benefit from the boom in AI investment spending and higher equity markets.

Provided a resolution to the Middle East conflict can be achieved relatively soon, the drag from this source should lessen allowing the fundamentals of a stronger US economy to benefit global growth. In Australia the recent rises in interest rates will be a headwind as the year progresses, especially for interest rate sensitive sectors such as housing and discretionary spending.

A prolonged closure of the Strait of Hormuz would present less favourable economic conditions, with fuel rationing and interruptions to activity as occurred during COVID lockdowns likely.

RBA expected to pause and assess economic conditions in June
The RBA’s Monetary Policy Board, after lifting interest rates at each of the three meetings so far in 2026, clearly guided that a pause in interest rate rises was likely in June. The tightening of policy to date has created space for the Board to observe the impact on the economy of both higher interest rates and higher energy prices, as well as to monitor the impact of both of these factors on inflation.

A pause does not mean the RBA has finished its tightening cycle. It’s clear that Australian inflation continues to run somewhere around 3.25-3.5% per annum, materially but not hugely above the RBA’s 2.5% target. If inflation fundamentals do not show additional signs of moderation in the next six to nine months, or if higher fuel prices see wages accelerate, the Board will need to consider still tighter policy.

It’s important to recognise that it’s the combined impact of higher interest rates and higher fuel prices that are currently impacting the economic outlook.  By the same token, if the Middle East conflict can be resolved, a 4.35% interest rate setting while challenging for many businesses and consumers, should not be high enough to cause broad-based economic weakness.

AUD/USD to maintain slow appreciating trend
Movements in the AUD are typically influenced by several key factors, including interest rate differentials between Australia and the United States, commodity prices and broader investor sentiment towards risk. While these models necessarily simplify a more complex state of affairs, they usually help explain broad movements in the exchange rate.

The Australian dollar has been in an appreciating trend against the US dollar since early 2025, assisted by general weakness in the USD as some of President Trump’s policies and pronouncements saw confidence in the USD reduce. The AUD did not immediately appreciate as the USD weakened but gradually gained support over 2025 and the first half of 2026 as the RBA relatively aggressively raised interest rates and previous correlations with gold and other metals including copper were re-established.

Provided global conditions remain broadly supportive and geopolitical tensions ease, the Australian dollar is likely to continue appreciating gradually against the US dollar over the period ahead. 

What it means for your business

• The combination of higher fuel prices and interest rates are making business conditions more challenging. A resolution to the tensions in the Middle East would likely lessen these pressures. That said, there are also opportunities provided by the boom in AI, along with stronger spending in defence and parts of the mining sector.
• The RBA is likely to monitor the economy and inflation for a time, after the three rapid interest rate increases in the first half of 2026. However, the conditions for any interest rate cuts seem a long way into the future and will require lower rates of inflation.
• The AUD will likely be well supported around current levels or rise slightly further against the USD in the second half of the year. Businesses should always consider how currency shifts could impact their pricing, costs, and competitiveness and consult their banker for advice on how to manage their currency exposures.