Australia’s economy continues to look more resilient to the current headwinds facing the global economy, with household spending and construction activity holding up better than in other developed economies. But there are now clear signs that the economy is running into capacity constraints, with employment total hours worked holding broadly steady since May (after a sustained period of strong growth post-Delta lockdown).

With demand still running stronger than supply, further domestic inflationary pressures are likely to be generated through wages and price setting behaviour, and it is appropriate that the RBA board continue to raise the cash rate to contain these. But given the extent of monetary tightening that has already been implemented, now is the time for the Board to slow the pace and assess the impact of what has already been put in place. Furthermore, the deterioration in the global environment will weigh on external demand.

A potential complication through the next twelve months will be developments in global currency markets, particularly the AUD:USD bilateral rate. While the AUD has outperformed most developed economy currencies this year (against the USD), import contracts are typically priced in USD, and a further sharp depreciation of the AUD would lead to further upward pressure on prices via imported inflation. But elevated prices for key commodities (particularly coal and natural gas) will provide support for the AUD, and a further normalisation of supply chains and shipping costs will also help to cool import prices. Overall then, inflation in Australia is still likely to peak at around 7.5%, well below other developed economies.