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Key Points:
- It remains a challenging business environment, with interest rates and fuel prices at the highest levels for some years, the AI investment boom driving technology and construction spending, and businesses and households continuing to absorb the significant cost increases of the past five years.
- Unfortunately, with the RBA still battling to slow the rate of inflation, it’s very likely that a further interest rate increase will be implemented at the November Board Meeting. The Board is then likely to pause for a number of months (February at the earliest), while it assesses the effects of the five interest rate rises over 2026 on the economy and inflation.
- While the labour market has eased a little and the unemployment rate has moved higher in recent months, inflation pressures remain stronger than expected, reinforcing the likelihood that interest rates will remain elevated for an extended period.
The economic outlook and RBA's November forecast revisions
The RBA publishes revised economic forecasts in its November Statement on Monetary Policy, which is released on Melbourne Cup Day alongside the November interest rate decision. In considering the likely forecast revisions and commentary on the outlook, the following points are worth noting:
- Recent higher monthly inflation outcomes and persistently higher-than-expected oil prices mean the RBA will have to revise up its near-term inflation outlook. The Deputy Governor recently described the inflation outlook as materially worse than the RBA expected in August. Without further adjustment to monetary policy, the Board has little chance of returning inflation to its 2.5% target in the second half of next year.
- The Board sees a period of slower economic growth as necessary to bring inflation back to target. The August forecasts foreshadowed GDP growth of around 1.5% in 2027. Given ongoing high inflation and the further boost from higher-than-expected oil prices, even slower growth may now be required.
- Offsetting some of these inflation concerns, the unemployment rate has trended a little higher in recent months and at 4.7%, is already at the rate the RBA expected late next year. There are reasons to be cautious in interpreting the most recent figures, as the ABS is modernising its survey methods, but the RBA cannot ignore the latest published data. The risk is that the updated forecasts could include a headline-grabbing unemployment rate of 5% by late next year or early 2028. Importantly, recent unemployment rises have reflected greater participation in the workforce rather than significant job losses.
My advice remains to be cautious about placing too much weight on the RBA’s forecasts, as I do not believe their models can accurately reflect or accommodate the number, size and nature of the shocks simultaneously impacting on the Australian economy at the present time.
Interest rate outlook - a further official cash rate increase in November
Late October has, in some ways, been a replay of the events that preceded the September rate increase. Both Deputy Governor Hauser and Assistant Governor Hunter have warned of significant pressures on inflation in the lead up to the November Board Meeting.
This appears to be a continuation of the concerns first raised in August and acted upon in September. With oil prices remaining extremely elevated and the RBA receiving reports of inflationary expectations shifting higher and becoming embedded in business decision-making, it’s unlikely that the September rate increase alone will be sufficient to return the rate of inflation to the 2.5% target late next year.
Alongside growing concerns about inflationary expectations, it has also been noticeable that the concerns of the impact on mortgage holders have been subordinated to join the broader negative impacts of continuing high inflation on the poorest members of society, on renters and indeed, on the entire population.
At the same time as the RBA has prepared the market and wider population for a further tightening in November, longer-dated interest rates have corrected a little lower. This has reflected a combination of a more moderate pace of further US interest rate rises, weakness in technology share prices amid some wobbles in the AI boom, and the longer end of US bond markets having already priced a near 5-5.25% peak for the US cash rate.
While the scale of AI investment may not be quite as significant as previously thought, it’s still expected to be massive. This is likely to maintain upward pressure on shorter-term US interest rates and likely prevent any early broader easing in interest rates in the US and Australia. A resolution to the Middle East conflict would be the factor most likely to bring about some nearer term interest rate relief.
What it means for your business
The combination of high interest rates, high fuel prices and the boom in AI investment is creating a very divergent outlook across sectors of the economy. For interest-sensitive sectors and businesses exposed to consumer discretionary spending, economic conditions are likely to become more challenging. By contrast, businesses exposed to technology and defence spending, including parts of construction and parts of mining and services to these sectors, are likely to continue to experience relatively favourable conditions.
As the RBA has still not managed to bring inflation under control, a further interest rate increase appears likely on Melbourne Cup Day, and any early reduction in interest rates seems unlikely. It’s likely that interest rates will remain unchanged after the November rise for some months while the RBA assesses the impact on the economy and inflation.
