Headline inflation has been running just shy of the RBA’s 2-3% target range at 1.9% for the last two quarters, while underlying inflation is 2.0% with the latest reading. The unemployment rate is 5.4% and real GDP growth is 3.1% on a year-on-year basis. These conditions are all consistent with an economy at or very close to potential. Wage growth has been weak. But it can be expected to pick up as previous downward pressure from increases in labour force participation cannot be sustained.

Given solid domestic conditions and a rise in global interest rates that will keep downward pressure on the exchange rate, the RBA can start to return its policy rate to a more neutral level over the next two years or so. It is possible that the neutral rate is lower than previously thought due to lower long-run productivity growth. However, it is likely to be consistent with a policy rate at least 2-3 percentage points higher than its current level.