IMF urges Australian governments to cut spending as another interest rate hike looms

The International Monetary Fund has called on Australia’s federal and state governments to cut spending as it warns the Reserve Bank may have to hike interest rates further to get price pressures back under control.

More disciplined budgets would rein in rising debt burdens and help solve Australia’s long-running inflation problem, the IMF said in a new report, as it downgraded its forecast for Australia’s economic growth in 2027.

In a “concluding statement” that followed annual consultations with Treasury, RBA and Australian Prudential Regulation Authority officials, the Washington-based institution predicted that the economy would grow by 1.9% this year.

But it shaved 0.1 percentage points off its forecast for real GDP growth to just 1.6% in 2027, flagging the downgrade was due to the higher likelihood of another RBA interest rate hike.

“Inflation remains a central challenge, while weak productivity growth is weighing on the economy’s potential,” the statement said.

“There is a risk that further large increases in global energy prices lead to stronger second-round effects and lift inflation expectations, warranting further tightening” in monetary policy.

The new assessment will come as a blow to Jim Chalmers, the treasurer, who is already under pressure to present a convincing story of improving living standards and prosperity.

Fuel prices in Australia are rising again after the worsening Middle East conflict pushed the global oil benchmark, Brent crude, above US$108 a barrel on Wednesday, marking a 35% surge since the start of August.

As global energy costs climb and threaten to spill over into domestic inflation, financial markets are pricing in an 80% chance of a RBA rate hike on 29 September.

The US Federal Reserve on Wednesday night voted to hike rates for the first time since 2023, threatening to reignite Donald Trump’s political attacks on the central bank.

The IMF largely backed Labor’s budget changes to investor taxes, although it noted concerns around unintended consequences.

Paulo Medas, the IMF’s mission chief, said previous consultations had identified that Australia’s property tax settings, including negative gearing, were “creating incentives for people to take more leverage and invest in housing” and adding to price pressures.

Medas told journalists on Thursday morning that the budget changes had created a more “balanced” set of incentives that could lead to more investment in other segments of the economy.

“That’s where we think it’s a positive change to the tax system, and hopefully helps on this affordability issue in housing.”

House price falls had done little to address unaffordable housing, the IMF said. It welcomed the steps taken to boost housing supply, even as it urged states and the federal government to do more.

The report noted that the combined federal and state deficit had widened over the past two years as states spent big on infrastructure projects, along with higher social services costs, especially in healthcare and the national disability insurance scheme.

There was also taxpayer money committed to cushioning the impact of the initial global energy price shock, most notably through cuts to the fuel excise.

New South Wales and Queensland spend more than twice as much on debt interest now than before the pandemic, according to Challenger.

And while “Australia’s overall public debt remains relatively low compared to many other advanced economies”, the IMF officials pointed to rising debts and interest costs, especially in state governments.

“The ongoing efforts to restrain general government spending, amidst strong private demand, would also support disinflation efforts by the RBA.”

In the longer term, poor productivity growth was “Australia’s key structural challenge”, the IMF said.

“Reversing the slowdown in recent years will be crucial to improving living standards” and making our public and private debt obligations sustainable over the long run.

The comments come before Monday’s release of the government’s latest intergenerational report, which will paint a long-term and likely challenging picture of Australia’s economy and budget.