Part 1 – AFIA’s Analysis of the Economic Outlook

Except as otherwise indicated, figures in Part 1 are drawn from Budget Paper 1 of the March 2025-26 Budget.  

Economic Trends 

The 2025–26 Budget is set against a backdrop of modest economic growth and persistent challenges. While inflation is easing and labour market conditions remain relatively strong, households continue to face cost-of-living pressures and higher interest rates. The global environment is also uncertain, with rising trade tensions and new tariffs from the United States weighing on business confidence and export demand. Domestically, natural disasters have disrupted activity, and weak productivity continues to constrain the economy’s longer-term potential. 

Real GDP growth is expected to remain modest in the near term, rising from 1.4 per cent in 2023–24 to 1.5 per cent in 2024–25, before strengthening to 2.25 per cent in 2025–26 and 2.5 per cent in 2026–27. The Budget attributes this gradual recovery to improving private demand and easing inflation, with growth expected to become more broad-based over the forecast period. 

The Government has also revised down its estimate of potential real GDP by 0.25 percentage points compared to MYEFO, citing ongoing weakness in productivity growth. Nonetheless, the medium-term outlook sees real GDP returning to 2.75 per cent growth by 2027–28 and 2028–29, consistent with pre-pandemic trends. 

Temporary disruptions from natural disasters, including Ex-Tropical Cyclone Alfred, are expected to weigh on activity in the short term, particularly across agriculture, construction, retail, transport and tourism. This could reduce quarterly GDP growth by up to 0.25 percentage points, although reconstruction efforts are expected to support output in subsequent quarters. 

The Budget models the impacts of the 25 per cent tariffs imposed by the United States on durable manufactured imports, estimating a modest negative impact on Australia’s real GDP by 2030. Reciprocal tariffs by China and Australia would see a greater negative impact.  

Household consumption growth remained weak in 2024 as many households faced ongoing cost-of-living pressures, including high mortgage repayments. However, with inflation easing, wages rising, and tax cuts in effect, real household disposable income has begun to recover. 

Real household disposable income is forecast to be 8.75 per cent higher in 2026–27 compared to 2023–24, supporting a gradual lift in consumption. Consumption is expected to grow by 0.75 per cent in 2024–25, and 2.25 per cent in both 2025–26 and 2026–27. 

The recovery in consumption is expected to remain gradual due to the lagged effects of high interest rates and cautious household sentiment. 

Dwelling investment is predicted to accelerate over the forward estimates, rising by 5.5 per cent in 2025–26 and 7.5 per cent in 2026–27. This follows a modest recovery of 1.5 per cent in 2024–25 after a contraction in 2023–24. The turnaround is being driven by strong underlying housing demand and a gradual easing of supply-side constraints in the construction sector. 

Business investment is forecast to grow by 1.5 per cent in 2025–26 and 2026–27, following strong growth in recent years. While the pace of growth is expected to moderate, the level of investment remains elevated by historical standards. Non-mining investment continues to drive activity, supported by investment in renewable energy, logistics and digital infrastructure. Mining investment is forecast to recover modestly as new LNG and metal ore projects stabilise production. 

Inflation has continued to moderate, with headline inflation expected to be 2.5 per cent through the year to the June quarter 2025, 0.25 percentage points lower than forecast at MYEFO. Inflation is now expected to sustainably return to the Reserve Bank of Australia’s target band around the middle of 2025, around six months earlier than previously expected. 

Underlying inflation has also eased, and inflationary pressures have broadly declined across goods and services. Lower fuel and construction costs, electricity rebates, and easing rental inflation have all contributed to this outcome. With inflation moderating more quickly than expected, near-term inflation and unemployment forecasts have both been revised down. 

The unemployment rate is expected to peak at 4.25 per cent, 0.25 percentage points lower than forecast at MYEFO. The participation rate is forecast to remain elevated at 67 per cent in 2025–26, while employment is projected to grow by 1.0 per cent in 2025–26 and 1.25 per cent in 2026–27, following strong growth in 2024–25.  

Australia’s labour market continues to perform relatively well compared to the United Kingdom, New Zealand and Canada, where unemployment has risen more sharply and employment outcomes have been weaker. 

The underlying cash balance in 2025–26 is expected to be a deficit of $42.1 billion, an improvement of $4.8 billion compared to MYEFO. Further improvements are expected across the forward estimates. 

Gross debt is expected to reach $1.022 trillion in 2025–26 (35.5 per cent of GDP) and peak at 37.0 per cent in 2029–30 before declining to 31.9 per cent by 2035–36. Interest payments have decreased since MYEFO, supported by lower yields and a reduced financing task. The assumed average cost of borrowing for Treasury Bonds has fallen slightly from 4.4 to 4.3 per cent, although it remains higher than the 2.2 per cent average at the 2022 PEFO. Interest payments are estimated to be 1.0 per cent of GDP in 2025–26 and are projected to peak at 1.6 per cent in 2032–33. 

Australia’s debt position compares favourably with other advanced economies. The IMF projects Australia’s gross debt-to-GDP ratio to be nearly 40 percentage points below the euro area, more than 50 points below the United Kingdom and over 70 points below the United States, ranking fifth lowest in the G20 in 2025.