Statement on Monetary Policy – May 20254. Outlook

4.1 The baseline forecast relative to the alternative forecast scenarios

Monetary policy affects the economy with a lag, so must always be set with an eye to how the economy is expected to evolve in the future. The RBA, like many other central banks, typically presents its economic outlook in the form of a central or baseline forecast. A baseline forecast can be thought of as the most likely single path for the domestic economy, given the technical assumptions on which the forecast is conditioned (such as the financial market-derived cash rate path). However, the economy is unlikely to evolve precisely as forecast. This is illustrated by the RBA’s fan charts, which we use to indicate a range of plausible outcomes around the baseline forecast (see the graphs below for GDP, unemployment and inflation, notably the blue-shaded areas). The width of the fans is based on past forecast errors.¹

However, where there are a number of different plausible outcomes, it can make more sense to evaluate the outlook using so-called ‘scenario analysis’, with the baseline being one of these scenarios. The heightened level of global uncertainty and the fast pace at which international trade policies have been evolving mean we are currently in such circumstances. Depending on the outcomes of current negotiations on future tariffs, the future paths for domestic activity and inflation may evolve in very different ways. Scenarios can never provide an exhaustive list of such outcomes; instead, we base our scenarios on different assumptions around how the international environment evolves that may lead to upside and downside risks to activity and inflation in Australia.

Table 4.1 provides a summary of the baseline and alternative scenarios that we examined in this round of forecasting. Each of these is discussed in turn below.

4.2 Key judgements for the baseline forecast

The key judgement underpinning the baseline forecasts is the assumption about the evolution of tariff policy, which is outlined in Table 4.1 and in Chapter 1: In Depth – Global Economy and Financial Markets. The three other important judgements that have been considered and debated extensively throughout the forecast process are discussed below.

Key judgement #1 – The slowing in Chinese growth will be modest, as the effects of higher tariffs and elevated uncertainty are mostly offset by increased policy stimulus.

Our baseline forecast is for MTP growth to slow in 2025 and 2026. Our baseline forecast for Chinese growth is currently towards the upper end of the range of market economists’ forecasts. This reflects our up-to-date baseline assumptions around the recent easing in tariff rates as well as our judgement that Chinese policy stimulus will offset much of the negative impact of tariffs and uncertainty on GDP growth; the Chinese authorities have communicated a growth target of ‘around 5 per cent’ for 2025 and a high appetite to use its policy levers to achieve that target. The possibility that further tariffs are introduced and/or that Chinese authorities are unable to offset the effect of the trade conflict presents downside risks to the domestic baseline forecast.

Key judgement #2 – Elevated global and domestic uncertainty is expected to weigh a little on domestic spending decisions.

Economic policy uncertainty has increased sharply alongside the recent escalation in global trade tensions. There is empirical evidence that increases in uncertainty weigh on private demand, over and above any effects that occur through other channels (e.g. declines in equity prices).² Heightened uncertainty increases the value of waiting for additional information and the baseline forecast assumes that uncertainty declines only gradually over the coming year (see Table 4.1). This results in some businesses delaying their investment decisions and households increasing their precautionary saving. This assumption has contributed modestly to the downward revision to forecast growth in domestic activity over 2025.

It is unclear how uncertainty will evolve going forward, and how Australian businesses and households will respond given the wide range of empirical estimates of the impact of uncertainty. At this stage, there is little evidence of any significant adverse effects of uncertainty on households and businesses in liaison or survey data. It is possible that business and household activity proves more resilient to the current level of uncertainty, with other factors proving more consequential for spending decisions (such as the assumed easing in monetary policy or because domestic policy uncertainty tends to decline once an election outcome is known). Alternatively, the effects of heightened uncertainty that have been assumed are small and could instead turn out to be larger, particularly if the trade conflict is larger or more protracted. These effects are explored in the alternative scenarios.

4.3 Baseline global outlook

GDP growth in Australia’s major trading partners has been revised downwards in 2025 and 2026 relative to the February Statement.

Consistent with the deterioration in timely partial activity data in many countries, the global outlook for 2025 has been revised lower by most forecasters (Graph 4.1). The wide range in published forecasts is indicative of the pace at which trade policies have been evolving and their likely effect on growth and inflation. To ensure our MTP forecasts are relatively consistent with the latest trade developments, we have deviated to some degree from our usual practice of using Consensus forecasts for the MTP (excluding China) forecasts and instead applied some judgement to the forecasts.

The downward revision in the baseline MTP forecast reflects the impact from the assumed set of tariffs described in Table 4.1 between the United States and its trading partners, particularly China, as well as an assumed additional effect on activity from the sharp increase in trade policy uncertainty. Growth in countries that impose and face tariffs will be most affected, while all countries will be impacted by the lower global demand from this shock. Overall, quarterly baseline MTP growth slows through 2025, before gradually picking up in 2026 as the direct effects of higher tariffs wane and uncertainty is assumed to decline, while stimulatory fiscal and monetary policy, particularly in China, is expected to continue to support growth.

Forecasts for US growth have been revised down substantially for this year and next year.

We expect quarterly growth in the United States to be weak in the second half of 2025 as the economy adjusts to higher tariffs, before picking up through 2026 as uncertainty eases. While the recent de-escalation of the US–China trade conflict likely reduces the probability, there is still some likelihood that the United States will be in recession by early 2026. Many market economists have assumed in their forecasts that the temporary personal income tax relief (scheduled to cease at the end of 2025) will be extended. Growth in most of our other trading partners, including economies in East Asia, has also been revised down but to a lesser extent than in the United States. The size of the downgrades is broadly proportional to the trade-exposure of the economy and its reliance on US demand.

The imposition of tariffs is expected to increase inflation in the United States this year. Consensus forecasters expect that this increase will be temporary and year-average inflation forecasts for 2026 have been relatively steady to date. The net impact of tariffs on inflation in most other advanced economies is expected to be relatively small, though inflation forecasts for some advanced economies were already drifting up before the spike in trade policy uncertainty (e.g. in Japan and the United Kingdom). Even if trade policy uncertainty is resolved completely, the higher tariffs will reduce the supply capacity of the global economy, weighing on potential growth and potentially adding to inflationary pressures (explored in the scenarios below).

4.4 Baseline domestic outlook

Australian GDP growth is expected to recover more gradually over 2025 than forecast three months ago.

The baseline forecast is for domestic activity to pick up over 2025 as consumption recovers and public demand continues to support growth (Graph 4.2). However, the recovery is expected to be more gradual than in the February Statement, for two reasons. First, the weaker outlook for global growth and increased policy uncertainty internationally is expected to weigh on growth in domestic activity. The lower forecasts for MTP growth and global goods prices will, all else equal, reduce demand for Australia’s exports and make imports relatively more attractive. Economic policy uncertainty has increased sharply alongside recent global developments, and this is expected to prompt some households to increase their precautionary savings and some businesses to postpone some investment decisions (see Key judgement #2 above).

Second, the partial data for the March quarter suggest that the recovery in household consumption that is underway has been less pronounced than thought in February, even after accounting for the expected impacts of Cyclone Alfred and other flooding (see Box B: The Impact of the Recent Floods on the Australian Economy). We have therefore revised down our expectations for near-term consumption growth. Consumption growth is still expected to pick up to around pre-pandemic rates of growth over coming years, supported by growth in real household incomes and the assumed easing in monetary policy.

The assumed cash rate path is expected to provide support to activity amid global economic headwinds. Financial market pricing now implies a slightly larger easing in the cash rate over the forecast period, which is expected to support aggregate household incomes and encourage dwelling and business investment by reducing borrowing costs. The exchange rate is broadly unchanged from February and is therefore providing little support to GDP growth relative to the February Statement; after depreciating sharply in early April following the announcement of tariffs by the US Government, this depreciation has since unwound amid improved risk sentiment and broad-based US dollar weakness (see Chapter 1: In Depth – Global Economy and Financial Markets).

Labour market conditions are expected to ease a little over the next year before stabilising at a level that is closer to balance compared with expectations in February.

The unemployment rate is expected to increase by slightly more over 2025 than expected in the February Statement (Graph 4.3). The unemployment rate has so far evolved as expected, remaining broadly steady at 4.1 per cent in the March quarter. Measures of hiring intentions and job ads were stable in early 2025 and remained broadly stable in April even as trade tensions escalated. Nonetheless, we expect the softer outlook for GDP growth in 2025 will result in a bit more easing in the labour market than previously thought. The unemployment rate is forecast to increase to 4.3 per cent over 2025 and is then expected to stabilise in early 2026 as GDP growth picks up further.

Employment growth is forecast to ease by more than expected at the February Statement. This reflects the downgrade to the outlook for GDP growth, which will weigh on labour demand. As a result, growth in employment is forecast to be below growth in the working-age population for a time. Average hours per employee are also expected to decline a little more than in the February Statement, as firms respond to weaker demand growth in part by reducing workers’ hours. The participation rate is expected to be broadly flat over the forecast period, as the continued trend of increased participation by females is offset by some discouraged workers leaving the labour force in response to weaker demand growth.

The baseline forecasts assume that the small increase in the unemployment rate brings the labour market closer to balance, though there is considerable uncertainty around estimates of full employment. Firms continue to report difficulties finding staff, and growth in unit labour costs is higher than is consistent with inflation being sustainably at target. At the same time, the observed decline in the rate of job-switching in the market sector might indicate less upwards pressure on wages growth and inflation than implied by the unemployment rate. Although our assessment of full employment has not been revised, our central forecasts for wages growth and inflation continue to incorporate some downwards judgement to reflect the risk that there is additional capacity in the labour market and economy more broadly.

Growth in nominal wages is expected to ease gradually over the coming year, alongside the easing in labour market conditions, before stabilising.

Private sector wages growth is expected to slow gradually in quarterly terms as conditions in the labour market ease. Wages growth is forecast to stabilise over 2026 at a slightly lower rate than previously forecast, owing to the softer outlook for the labour market relative to the February Statement (Graph 4.4). As in February, we have applied some downward judgement to the wages growth forecasts to incorporate the risk that we have overestimated the extent of excess demand in the labour market. Public sector wages growth is forecast to remain elevated over the remainder of 2025 – as several large agreements are renewed – before easing progressively over the remainder of the forecast period. Both the renewal of these large public sector agreements and announced administered decisions for several large awards may also contribute to increased quarterly volatility in the Wage Price Index.

Growth in unit labour costs (ULCs) is expected to begin easing in late 2025. Growth in nominal ULCs – the measure of labour costs most relevant for firms’ cost of production and so for inflation outcomes – has been elevated in recent years. However, this is expected to slow in line with easing growth in nominal wages and a projected pick-up in productivity. ULCs are expected to reach a rate broadly consistent with inflation being sustainably at the midpoint of the target range by around the middle of the forecast period; this is a little earlier than in the February Statement.

Year-ended underlying inflation is expected to remain within the 2–3 per cent range over the forecast period, and to settle at around the midpoint of that range.

The outlook for underlying inflation has been revised lower over the forecast period since the February Statement (Graph 4.5). This is consistent with the downward revision to the growth outlook and the small downward revision to import prices. The March quarter inflation data provided further confidence that housing inflation and market services inflation have fallen markedly over the past year. Inflation in new dwelling costs is expected to remain weak in the near term, partly reflecting the earlier softening in demand for new housing, before picking up alongside dwelling investment. CPI rents inflation is expected to ease as the earlier moderation in advertised rents growth gradually flows through to the stock of rents measured in the CPI. Market services inflation is expected to be a little weaker than previously thought, reflecting the softer outlook for the labour market. In the near term, downward pressure on firms’ margins may continue to weigh on inflation until demand picks up, with some firms reporting in liaison that weak demand has limited their ability to pass on cost increases to prices.

The outlook for retail goods prices is subject to considerable uncertainty due to international developments. Under the baseline forecast, we have judged that the trade scenario set out in Table 4.1 is likely to have only a small effect on domestic inflation over the forecast period (see Key judgement #3 for the baseline forecast). Similar to the February Statement, we have incorporated some downward judgement to the inflation forecasts due to the risk that we have overestimated the extent of excess demand in the labour market. Inflation expectations are assumed to remain consistent with achieving the inflation target over the long term.

Measured in headline terms, year-ended CPI inflation is expected to increase over the second half of 2025 to be above 3 per cent, before returning to around the midpoint of the target range later in the forecast period (Graph 4.6). This volatility is due to the unwinding of cost-of-living measures, such as electricity rebates (as currently budgeted). The pick-up in headline inflation has been delayed by the extension of the Electricity Bill Relief Fund in the 2025–2026 Australian Government Budget. The recent decline in oil prices is expected to weigh on headline inflation in the near term. Headline inflation is forecast to converge towards underlying inflation once these temporary factors have passed. Because headline inflation can be affected by large swings in the prices of individual items, we will continue to pay close attention to underlying measures as an indicator of momentum in consumer price inflation.³

4.5 Alternative scenarios

Relative to the baseline scenario, the distribution of outcomes for the global outlook are judged to be skewed to the downside. There is considerable uncertainty about the wide range of possible levels that tariffs could settle at, and uncertainty about the impact on the global economy and financial markets. There is also uncertainty around the configuration of other economic policies, such as global fiscal policies or US deregulation policies in this environment. The scenarios set out in Table 4.1 can be used to illustrate the range of possible outcomes and are discussed in more detail below.

‘Trade war’ scenario – an escalation in the trade conflict leads to a protracted trade war.

The recent US–China trade agreement removes some of the downside risks to global growth. However, it remains very possible that the current situation deteriorates into a more widespread and protracted ‘trade war’, which would present large downside risks to domestic GDP growth and lead to higher unemployment.

Using the assumptions outlined in Table 4.1, we have constructed such a scenario using the Global Economic Model from Oxford Economics and MARTIN (the RBA’s macroeconometric model). There are significant challenges in using modelling frameworks to quantify the effects of uncertainty or complexities from shocks that are outside the range typically seen. The outcomes of this scenario are as follows:

• The permanent and large increase in tariffs comes as a big surprise to financial markets, businesses and households, and triggers a large global confidence shock that leads to sharp declines in asset prices, business investment and consumption. There is a sharp and disorderly decline in asset prices in which the initial confidence shock is amplified in financial markets – for example, highly-leveraged trades could be unwound – leading to a cycle of further asset price declines.
• The level of MTP GDP is projected to be 3 per cent lower than our baseline forecast by the end of 2027 (which is a larger decline than during the global financial crisis). The level of Chinese GDP is around 4 per cent lower than our baseline forecast over the same period. This is because, in the scenario, the scope for trade diversion of Chinese exports is limited by the scale and increased coverage of tariffs and weak global demand, and because any fiscal response from Chinese authorities is assumed not to be material enough to meaningfully offset the weakness in demand.
• Inflation overseas is expected to increase in the near term as trade fragmentation leads to higher import prices for most economies, but this is temporary as the weaker GDP outcomes become disinflationary.
• The expected cash rate is fixed at the baseline assumption (and assumes a cumulative 85 basis points of easing by mid-2027). However, the Australian trade-weighted index depreciates by 6 per cent alongside weaker global growth. The level of domestic GDP is more than 3 per cent lower than the baseline forecast (Graph 4.7). Much of the decline is led by consumption and business investment from the confidence shock. Household wealth declines, while businesses become risk averse and reduce investment. The depreciation of the exchange rate provides some support to activity; however, the unemployment rate increases to nearly 6 per cent.
• The shock to domestic demand and higher unemployment weighs on wages growth and inflation, with inflation declining to around 2 per cent by the end of 2027.

It is possible that a protracted trade war leads to global inflationary pressures.

The baseline forecast and the trade war scenario described above are judged to be disinflationary for Australia as world trade prices respond to weaker global demand. However, it is also possible a protracted trade war could fuel inflationary pressures.

In a protracted trade war, a much larger share of world trade would be affected by tariffs and it would be hard for most firms to avoid the impact of higher tariffs affecting some stage of their production. Sourcing intermediate inputs would become more difficult, and it would take some time for businesses to adjust their supply chains to minimise exposure to tariffs. It is possible that, even in an environment of much weaker demand, businesses have to pass on these costs to higher prices.

There may also be inflationary pressures from a protracted trade war that take longer to appear. Higher tariffs can reduce productivity growth in affected economies via misallocation of resources, a reduction in business investment and less incentive to innovate. Persistent inflationary pressures could emerge if incomes and demand did not moderate in line with the relatively lower supply capacity of the economy.

Finally, while longer term inflation expectations have remained relatively well anchored following the recent high-inflation period, there is a risk that a return to higher inflation before inflation had sustainably returned to the target band may see a drift higher in inflation expectations. The weaker outlook for demand and higher unemployment would make it more challenging for global central banks to tighten monetary policy to reduce inflation, which could see higher inflation expectations become entrenched.

‘Trade peace’ scenario – there is a swift resolution of the trade conflict.

A key upside risk to the global baseline forecast is a sharp de-escalation of the trade conflict. One scenario might be that successful negotiations between the United States and its key trading partners leads to a permanent resolution to the trade conflict which lowers tariffs back to 2024 levels and reduces global policy uncertainty. While the conflict to date has likely had some adverse effects on trade, business and household spending decisions, overseas growth could end up higher than in the baseline forecast if the de-escalation occurred alongside stronger-than-expected fiscal stimulus in advanced economies and China, or the introduction of non-trade policies in the United States that stimulate growth.

This scenario is likely to involve limited lasting scarring effects on Australian businesses and households from the (assumed temporary) escalation in the trade conflict over recent months. As such, it is possible that the expected recovery in domestic demand would be more pronounced than in the baseline forecast, as elevated uncertainty would no longer weigh on consumption and investment growth over 2025. This might see a re-emergence of the concerns outlined in the February Statement of excess demand in the labour market and the economy leading to inflationary pressures. In this scenario, less accommodative policy than is currently priced into market expectations for the cash rate may be required.

4.6 Detailed forecast information

Table 4.2 provides additional detail on the baseline forecasts of key macroeconomic variables. The forecast table from current and previous Statements can be viewed, and data from these tables downloaded, via the Statement on Monetary Policy – Forecast Archive.

Download a PDF version of this table

Endnotes

For more information on this, see Tulip P and S Wallace (2012), ‘Estimates of Uncertainty around the RBA’s Forecasts’, RBA Research Discussion Paper No 2012-07. 1

For example, see Bloom N (2009), ‘The Impact of Uncertainty Shocks’, Econometrica, 77(3), pp 623–685; Moore A (2016), ‘Measuring Economic Uncertainty and Its Effects’, RBA Research Discussion Paper No 2016-01. 2

See RBA (2024), ‘Box C: Headline and Underlying Inflation’, Statement on Monetary Policy, August. 3