Government action needed to avoid higher interest rates: IMF

The Reserve Bank may have to keep lifting rates, the International Monetary Fund has warned, with inflation likely to stay above target into 2026 unless federal and state governments do more to spread the burden of high prices across the economy.

The global financial agency backed calls for cost-of-living relief, recommending the federal government step in with more “well-targeted stimulus measures” to ensure those struggling the most were not left behind if inflation remained high.

Treasurer Jim Chalmers says the IMF report is an endorsement of the government’s budget repair process and policy strategy.Credit: Alex Ellinghausen

Amid ongoing debate about whether the federal government should keep the stage 3 tax cuts, which are due to start from July 1, the IMF also called for major tax reform while urging governments to slow the rate of infrastructure spending to ensure it does not add to inflationary pressures.

In its economic health check report for Australia, the IMF said it expected Australia to avoid a recession but forecast inflation to return to the target range of 2-3 per cent during 2026, later than the Reserve Bank’s forecast of December 2025.

The report was completed after the RBA lifted interest rates by a quarter of a percentage point to 4.35 per cent at its November board meeting.

The IMF noted that while interest rates were tightening financial conditions, the pace of rate rises had been behind other advanced economies.

Its report also said Australia’s inflation was falling slowly, reaching 5.4 per cent in the September quarter, but that services inflation remained a problem. With a tight jobs market, the IMF warned the fall in inflation could slow further in the near term, aided by strong immigration.

“Monetary policy should be tightened further to ensure inflation comes back to target earlier than 2026 projected in the baseline,” it argued.

“The pace of further tightening needs to be calibrated based on incoming data and should consider the lags in the transmission of the effects of monetary policy.”

Slowing labour force data and sluggish consumer spending figures released this week had firmed hopes of interest rate cuts in the second half of 2024, with some economists saying they could come even sooner if December-quarter inflation data was weaker than expected.

The IMF also noted that income tax rates were high, and bracket creep – where income growth caused people to pay higher average income tax rates each year – meant workers were shouldering more of the burden of growing government spending on the ageing population.

“The 2023 intergenerational report underscores the growing dependence on bracket creep in the absence of tax reforms,” the IMF said.

“Addressing these challenges head-on will avoid costly delays in tax reforms needed for sustained and shared prosperity.”

As Victoria and NSW continue to debate land tax versus stamp duty, the IMF said using recurring property taxes instead of stamp duty would help housing affordability and provide more stable state tax bases over time.

The IMF said the government’s budget management and commitment to debt sustainability was welcome after Labor saved most of the record $21 billion surplus from last financial year, but recommended the government do more to avoid the need for further interest rate rises.

“Further rate hikes will likely be needed in the absence of supportive alternative policies,” the report said, adding federal and state governments should take a “more measured and co-ordinated” approach to infrastructure projects to support the RBA’s efforts to rein in inflation.

Higher interest rates had mostly affected lower-income households with mortgages, the report said, which had added to the financial pressures from high inflation.

“Alternate tools, such as fiscal policy, must ensure that other sectors of the economy do their part,” it said.

It added that if inflation remained high, the government should step in to help those most vulnerable to the current economic pressures.

“If inflation remains elevated, fiscal policy should weigh in, with time-bound, well-targeted stimulus measures (eg, low-income tax offsets) to support inclusive growth,” the IMF said.

Prime Minister Anthony Albanese said this week the government was still exploring options for additional cost-of-living support in the lead-up to the May budget.

The IMF noted housing affordability was an ongoing concern, with property prices about 30 per cent higher than pre-pandemic levels and rising mortgage payments pushing home ownership further out of reach for many.

The Australian economy is expected to avoid a recession, and remains strong despite cost-of-living pressures.Credit: Dion Georgopoulos

“A greater housing stock is needed urgently. The authorities have planned a suite of housing policies, which if implemented, would boost supply, helping affordability,” the report said.

Treasurer Jim Chalmers said the IMF report was an endorsement of the government’s budget repair process and its policy strategy across areas including housing, competition, and skills and training.

“The report makes it clear that our government is doing better than other countries’ when it comes to getting our budget into much better condition as a buffer against the global economic uncertainty ahead,” Chalmers said in a statement.

“There is no shortage of challenges in the economy, including high but moderating inflation, higher interest rates, natural disasters and global uncertainty, which are all weighing on growth, but this report confirms Australia comes at these from a position of genuine economic strength.”

Shadow treasurer Angus Taylor said the report confirmed the Australian economy was struggling under Labor.

“Most damning, the IMF has called out Labor’s weak budget management and migration policies as making inflation worse,” Taylor said in the statement.

“The IMF predicts that Australia’s inflation will be too high for another two years.”

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