Westpac: AI data centre, renewables will force rate hikes despite early 1990s recession-type growth

The AI and renewable energy revolutions could force the Reserve Bank to hike rates even higher despite a prediction the Australian economy will this year grow at a sluggish pace comparable with the early 1990s recession.

Westpac, Australia’s second biggest bank by value, has revised its forecasts to have gross domestic product expanding by just 0.7 per cent in 2026 with consumer sentiment at historically weak levels.

As recently as March, Westpac was forecasting a one per cent growth pace for this year.

Australia’s economy is tipped to suffer the worst slowdown since 2020, when GDP plunged by 1.1 per cent over a year that included COVID lockdowns that sparked the first recession in 29 years.

Outside of the pandemic, sluggishness in 2026 would mark the weakest pace of economic activity since 1991, another year of recession which saw Australia’s economy grow by just 0.4 per cent.

A contraction for the June quarter of 2026 is now rated as a 27 per cent chance with a follow-up shrinkage during the September quarter seen as a one-in-ten probability that would spark a technical recession.

“Particularly for consumers, it’s going to feel potentially like a recession,” Westpac senior economist Pat Bustamante told The Nightly.

This would make it harder for sectors like hospitality and retail to expand, with Westpac tipping two more rate rises in August and September that would take the Reserve Bank cash rate to an 18-year high of 4.85 per cent.

While consumer spending is weak, $155 billion of capital expenditure on new artificial intelligence data centres during the coming decade and the $200 billion transition to renewable energy are fuelling inflation by adding to overall demand in the economy, leading to higher interest rates than otherwise.

Together, they are expected to make up 13 per cent of the economy.

“Had we not had that source of additional demand growth through investment in renewables and data centres, maybe the Reserve Bank wouldn’t need to step on the consumer or slow down consumer spending as much because demand and supply would be in balance,” Mr Bustamante said.

“But it’s just that we’ve had this shock.

“We know demand on the consumer side is slowing quite significantly but on the investment side, it’s accelerating from a higher level so it’s adding to demand.”

Data centre construction with imported high-tech equipment is particularly concentrated in NSW and Victoria, Australia’s two most populated states that haven’t benefited as much from a mining boom.

These states, home to Sydney and Melbourne, have also experienced weaker per capita consumer spending since 2019, compared with other states like Western Australia and Queensland that had seen an income boost from higher commodity prices.

Transport infrastructure spending in NSW and Victoria has also peaked, as higher interest rates push up government bond yields.

“The combination of higher borrowing and elevated interest rates is driving a sharp increase in net interest payments, adding to fiscal pressures over the medium term and reducing Budget flexibility,” Westpac said.

“At the same time, higher inflation and rising costs continue to push up state government expenditure.”

Westpac is expecting two more interest rate rises to slow the property market and strip the states of a combined $6.5 billion in stamp duty revenue in the 2025-26 and 2026-27 financial years as Federal Labor’s changes to negative gearing and the 50 per cent capital gains tax discount turned off investors.

“The tax policy changes mean investor activity is likely to be permanently lower as well,” it said.

Beyond 2026, Westpac is expecting economic growth to recover to 1.5 per cent in 2027, rising to 2.6 per cent by 2028 as easing inflation enabled the RBA to cut rates.

The Reserve Bank’s two rate hikes in February and March had yet to slow investor borrowing demand with 10.8 per cent of new such loans having a debt-to-income ratio of at least six in March, up from 8.2 per cent in March 2025, new Australian Prudential Regulation Authority data released on Monday showed.

The owner-occupier share of the housing market had also fallen to 62.4 per cent, down from 64.3 per cent, as the investor share of new loans climbed to 35 per cent from 33.5 per cent, with the data taken before the May 12 Budget changes to negative gearing and capital gains tax concessions.