The Australian economy has arrived at a precarious intersection where the momentum of post-pandemic recovery is colliding with the restrictive realities of monetary tightening. Central to this unfolding economic narrative is the labour market, which has exhibited behaviour that defies simplistic categorisation. The release of labour force data in late 2025 provided a shock to the system that forced a re-evaluation of the Reserve Bank of Australia’s policy trajectory.
The rise in unemployment starting in September showed deeper changes happening in Australia’s workforce. It hit 4.5%, the highest since November 2021. Things got psychologically and economically worse as the unemployment rate crossed the 4% mark, signalling the conclusion of the era of ultra-low unemployment.
Jeff Borland, Professor of Economics at The University of Melbourne, recently prepared an analysis that highlighted a critical divergence where the economy was creating jobs at a slower pace than the population was expanding.
In 2025, the Australian economy added an average of approximately 12,900 new employed persons each month. While this indicates positive growth, it fell woefully short of the labour supply expansion. The number of people looking for work grew by an average of 22,100 per month during the same period.
This phenomenon is deeply rooted in Australia’s demographic trends, particularly the high rate of net overseas migration, which has sustained population growth at approximately 2.0% per annum. In contrast, total employment growth over the year to November was only 1.3%.
This gap of 0.7 percentage points represents a structural widening of labour market slack that monetary policy is specifically designed to induce. The Reserve Bank of Australia has maintained a restrictive cash rate setting precisely to cool the demand for labour and align it more closely with supply capacity. The September 2025 data suggested that this transmission mechanism was working, perhaps faster than anticipated.
However, the narrative became more complex with the release of data for October and November 2025, which showed a reversion of the unemployment rate to 4.3%. This volatility raises questions about the reliability of monthly seasonally adjusted figures and suggests that the September spike may have been amplified by statistical noise or temporary sampling variations.
Nevertheless, the broader trend lines confirm a softening market. By November, the stability of the 4.3% rate masked a deterioration in the quality and composition of employment. The Australian Bureau of Statistics reported that the total number of employed people actually fell by roughly 21,000 in November. The only reason the unemployment rate did not rise in response to this job shedding was a simultaneous decline in the participation rate, which fell from 66.8% to 66.7%.
The decline in participation is a critical indicator of discouraged workers exiting the labour force. When job seekers stop actively looking for work, they are no longer counted as unemployed, which artificially depresses the headline rate. This “hidden unemployment” suggests that the labour market is weaker than the 4.3% figure implies.
Full-time employment, which provides the income stability necessary for household consumption and debt servicing, plummeted by 56,500 positions in November. This loss was only partially offset by an increase of 35,200 part-time positions. This substitution of full-time roles for part-time roles is a classic defensive strategy by employers who are uncertain about the future economic outlook and unwilling to commit to permanent salary obligations.
The rise in the underemployment rate further corroborates the thesis of increasing slack. The underemployment rate, which measures employed persons who want and are available for more hours, rose to 6.2% in November. This metric is particularly sensitive to the cost-of-living crisis, as workers seek additional hours to cope with high inflation and interest rates.
A rising underemployment rate in an environment of falling real wages represents a significant squeeze on household welfare. When combined with the unemployment rate, the total labour force underutilisation rate pushed above 10.5% in late 2025, signalling that despite the “tight” rhetoric, there is a substantial reserve of unutilised labour capacity building up in the economy.
It is also important to consider the independent estimates provided by Roy Morgan (Australia’s oldest and most well-known independent market research company), which utilise a different methodology to the Australian Bureau of Statistics.
In September 2025, Roy Morgan estimated the “real” unemployment rate at 10.8%, with a combined unemployment and underemployment count involving 3.2 million Australians.
While the Australian Bureau of Statistics definition is the global standard for monetary policy formulation, the Roy Morgan figures highlight the lived experience of millions of Australians who feel the bite of a slowing economy more acutely than the official statistics suggest.
The discrepancy between these measures often widens during economic downturns, as the strict criteria for being “unemployed” (active search within the last four weeks and availability to start immediately) exclude those on the margins of the workforce.
Why prices refuse to budge
While the labour market is showing clear signs of cooling, the inflation landscape in Australia has remained stubbornly resistant to the dampening effects of monetary policy. Wages, prices, and productivity are feeding into each other, creating a cycle that keeps inflation higher than the Reserve Bank of Australia’s 2% to 3% goal. New data from late 2025 showed that inflation is still a serious problem and will need strict policies for a longer time.
In October 2025, inflation rose to 3.8%, up from 3.6% in September, with increases seen across many basic goods. The trimmed mean inflation, which is the Reserve Bank’s preferred measure of underlying price pressures, also moved higher to 3.3%. These figures confirmed that the disinflationary process had stalled and, in some areas, reversed.
Housing costs have emerged as the single largest contributor to this inflationary persistence. In October, housing inflation ran at 5.9%. This category is driven by two powerful forces that are largely immune to interest rate hikes in the short term. The first is the rental market, which is experiencing a severe crisis of supply. With vacancy rates at record lows and population growth continuing at a rapid pace, landlords have significant pricing power.
Rents have surged across all major capital cities, adding a heavy weight to the inflation basket. The second factor is the cost of new dwelling purchases, which remains elevated due to high construction costs. Labour shortages in the trades, combined with the high cost of materials, have kept the price of building new homes high even as demand for new approvals has softened.
The Wage Price Index for the September quarter rose by 0.8%, taking the annual growth rate to 3.4%. While this figure is below the peak seen in previous years, it remains high relative to the abysmal productivity performance of the Australian economy.
Productivity growth, which measures the output produced per hour worked, has been flat or negative for several quarters. When wages rise without a corresponding increase in productivity, the unit labour cost for businesses increases.
To maintain profit margins, businesses must pass these higher costs on to consumers in the form of higher prices. This wage-price dynamic is particularly evident in the service sector, where productivity gains are harder to achieve than in manufacturing or agriculture.
The divergence between public and private sector wage growth adds another layer of complexity. The 3.8% annual growth in public sector wages acts as a floor for wage expectations across the economy. State government enterprise agreements, particularly in the healthcare sector, have locked in wage increases that will sustain income growth for a large portion of the workforce.
While these increases are necessary to attract and retain essential workers, they also support aggregate household income and spending power. This fiscal impulse counteracts the monetary contraction sought by the Reserve Bank. Private sector wages, which grew at a more modest 3.2%, are showing signs of responding to the slowing economy, but the aggregate effect is diluted by the strength of the public sector.
The persistence of inflation has forced a recalibration of the “soft landing” narrative. The hope that inflation would glide effortlessly back to target while unemployment remained low has been replaced by the realisation that a more prolonged period of sub-trend growth and higher unemployment may be required to break the back of domestic price pressures.
The Reserve Bank’s revised forecasts in the November Statement on Monetary Policy projected that inflation would remain above the target band for “a while” and would not return to the midpoint until late 2027. This extension of the timeline reflects an admission that the embedded inflation expectations in the economy are harder to dislodge than previously thought.
While the Consumer Price Index measures the rate of change in prices, the accumulated level of prices remains permanently higher. The price of essential goods and services such as food, health, and housing has absorbed a significant portion of household budgets, leaving less room for discretionary spending.
This is evident in the GDP data, which showed a 0.2% decline in discretionary consumption in the September quarter. Households are prioritising survival spending over lifestyle spending, a shift that has ripple effects through the retail and hospitality sectors.
The island’s policy of isolation
The Reserve Bank of Australia has entered a phase of policy paralysis characterised by a high-wire act between a softening economy and sticky inflation. The decision by the board to leave the cash rate unchanged at 3.60% at its final meeting of 2025 was widely expected, yet it highlighted the unique and difficult position in which Australia finds itself relative to the rest of the developed world.
While other major central banks have commenced easing cycles to support growth, the Reserve Bank of Australia remains locked in a restrictive stance, with the threat of further hikes still lingering in its forward guidance.
The December decision was unanimous, but the accompanying statement revealed a hawkish tilt that surprised some market participants. Governor Michele Bullock made it unequivocally clear that “cuts were firmly off the table.” The contrast with the United States Federal Reserve is particularly stark.
In December 2025, the Federal Reserve cut its benchmark interest rate by 25 basis points to a target range of 3.50 to 3.75%. This marked the third consecutive rate cut by the US central bank, driven by a cooling labour market where unemployment had risen to 4.4% and a greater confidence that inflation was on a sustainable path to target. The European Central Bank (ECB) and the Bank of England (BoE) have also moved to lower rates, responding to weaker growth profiles in their respective economies.
This divergence in monetary policy trajectories has significant implications for the Australian economy, particularly through the exchange rate channel. Typically, when the Reserve Bank of Australia holds rates steady while the US Federal Reserve cuts the interest rate, the differential shifts in favour of the Australian dollar.
A stronger Australian dollar makes imports cheaper, which provides a disinflationary impulse for tradable goods such as electronics, fuel, and vehicles. However, the Reserve Bank cannot rely on this mechanism to solve its inflation problem because the current inflation basket is dominated by non-tradable items like housing and services, which are largely insensitive to exchange rate movements.
The banking sector has responded to this new reality by revising its interest rate forecasts for 2026. The consensus among the “Big Four” banks has fractured. Commonwealth Bank, National Australia Bank, and ANZ have all shifted their views to predict an extended pause throughout 2026. These institutions now believe that the cash rate will remain at 3.60% for the foreseeable future, acting as a constant drag on the economy until inflation is decisively defeated.
In contrast, Westpac remains an outlier, forecasting two rate cuts in 2026, tentatively scheduled for May and August. Westpac’s economists argue that the current spike in inflation is driven by temporary anomalies that will wash out of the data, allowing the Reserve Bank to pivot mid-year to support growth.
Financial markets have taken an even more aggressive view, with interest rate swaps pricing in a significant probability of a rate hike by June 2026. This reflects the anxiety that inflation may have become structurally embedded at a level above 3%, which would require a second round of tightening to dislodge.
A return to rate hikes would be politically explosive and economically damaging given the fragility of the household sector, but the Reserve Bank has consistently stated that it will do “whatever is necessary” to return inflation to target.
The impact of this “higher for longer” regime is evident in the flow of credit and investment. While business investment has remained surprisingly resilient, rising 3.4% in the September 2025 quarter due to spending on data centres and digital infrastructure, household credit growth has slowed.
The “mortgage cliff,” which referred to the transition of borrowers from low fixed rates to high variable rates, has now evolved into a “mortgage plateau.” Borrowers have absorbed the shock of higher payments, but they have done so by slashing discretionary spending and drawing down on savings buffers. The prospect of no rate relief in 2026 means that this financial stress will be prolonged, increasing the risk of mortgage arrears and defaults as savings pools are eventually exhausted.
The Reserve Bank’s strategy relies on the assumption that the labour market will remain “healthy” enough to absorb this prolonged period of restriction. The forecast that the unemployment rate will stabilise around 4.5% allows the bank to prioritise inflation fighting. However, as the September spike demonstrated, labour market dynamics can shift rapidly.
If the unemployment rate were to accelerate toward 5.0%, the Reserve Bank would face a much sharper dilemma involving a choice between abandoning its inflation target or accepting a recession. For now, the board judges that the risks to inflation are greater than the employment risks, but this calculus will be tested in the coming months as the full lag effects of monetary policy continue to work their way through the economy.
Should the unemployment rate be held below 4.7% while inflation slowly moderates, the economy may achieve the elusive “soft landing.” This would involve a period of below-trend growth but no catastrophic collapse. However, the risks are tilted to the downside.
If the September unemployment spike was not an anomaly but a leading indicator of a sharper deterioration, the Reserve Bank may be forced to pivot rapidly. A sudden jump in unemployment would likely shatter consumer confidence and trigger a rapid deleveraging cycle in the housing market.