Australian economy: International Monetary Fund says RBA must keep rates elevated until inflation fight is won

Australia has been urged to keep interest rates elevated as long as necessary and cut government spending to finally end the country’s five-year long inflation battle.

The International Monetary Fund published a review of the national economy on Thursday morning and took particular aim at State Governments for rising debt.

It also called on Treasurer Jim Chalmers to be “more ambitious” about tax reform and housing supply to improve long-term living standards.

Yet the Washington-based experts remain optimistic about Australia, declaring that the country had “structural strengths” with relatively low public debt and a skilled workforce. Australia started 2026 from “a position of strength”, the six-page report said.

The news will be sobering for borrowers in the lead up to the Reserve Bank’s meeting later this month.

Markets give a three-in-four chance the RBA will lift the official cash rate to 4.6 per cent thanks to core inflation remaining above target at 3.6 per cent for the year to July.

The IMF has called for the RBA to go harder and said it should “stand ready to hike rates as needed”.

“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,” the IMF said.

Even a downturn would not be enough to force the central bank to ease the pressure unless price rises get under control, as any future rate cuts must be “contingent on sustained progress in reducing underlying inflation”, the IMF said.

Government spending, which this year hit the highest share of the economy in four decades aside from COVID-19, would need to come under control to help the cost of living fight.

“The combined fiscal deficit of the Commonwealth and state governments widened over the past two fiscal years,” the report said.

“(That reflects) large infrastructure investment by states, rising social spending, especially healthcare and the National Disability Insurance scheme, and response to the global energy price shock.”

While noting Australia’s public debt was lower than most other advanced countries, the IMF said spending cuts would help the RBA slow inflation and rebuild “buffers”.

Controversial Federal Budget changes to wind back capital gains tax concessions and negative gearing for housing were endorsed as they would help fix distortions in the property market but the IMF said a “more ambitious and coordinated supply agenda is needed”.

“While housing market weakness has broadened across regions and price segments, the correction follows a period of strong price growth and has not materially eased affordability pressures, as supply remains constrained,” the report said.