Australia’s Long Road Back to the Inflation Target

Australia’s headline inflation remains above the Central Bank (RBA) 2–3 per cent target band. Annual headline CPI inflation reached 4.0 per cent in August 2026, up from 3.5 per cent in July and well above the target range. Although inflation has eased from its 4.6 per cent peak in March 2026, the decline has been gradual, with inflation expected to remain above target for some time. Sourced from the ABS, the FWPA chart breaks down headline CPI inflation by expenditure group. Housing is the largest contributor, adding approximately 1.2 percentage points to annual inflation. Transport is the second-largest contributor, with its contribution fluctuating in line with fuel prices and broader global market uncertainties. Food and grocery-related items provide a relatively stable contribution, while health, education, and other expenditure categories account for the remaining inflationary pressures.

Inflation forecast to moderate to 3.5% by End-2026

FWPA expects headline CPI inflation to ease gradually over the remainder of 2026, from 3.8 per cent in September to 3.5 per cent in December. Despite this moderation, housing and transport are expected to remain the two largest contributors to inflation. Transport remains the main source of uncertainty. The volatility in global oil prices indicates that supply disruptions could quickly push up petrol prices and freight costs, adding to inflationary pressure.

Housing costs are also expected to remain high. The RBA has increased the cash rate to 4.60 per cent, following earlier increases to 3.85 per cent (February), 4.10 per cent (March), and 4.35 per cent (May). For housing owners, higher interest rates increase mortgage repayments and place additional pressure on household budgets, while rents remain firm amid tight housing supply.

Households pull back as interest rates rise

Higher interest rates are expected to weigh on household spending. As mortgage repayments absorb a larger share of disposable income, households are likely to reduce discretionary expenditure, particularly on recreation, dining out, and holidays. This should moderate demand-driven inflationary pressures in these categories.

Weaker household spending will also affect businesses, particularly in retail and tourism sectors, as well as industries linked to residential construction and renovation. For the forest and wood products industry, softer housing-related activity could further constrain demand depending on the outlook for dwelling construction and renovation investment.

Figure 1: Headline CPI by Group and Its Forecast

Sources: ABS, FWPA analysis

Higher rates and uncertainty in the next 12 months

The outlook is more challenging due to monetary policy. The RBA has raised rates four times this year, most recently this month to 4.6%. Higher borrowing costs reduce serviceability for owner-occupiers and investors, and raise financing costs for developers and builders. Approvals are the first part of the pipeline to react, followed by commencements.

There is a risk that approvals and commencements weaken in 2027, reducing demand for structural timber just as supply chains adjust to the recent increase in activity. Timber suppliers should continue to monitor approvals and commencements as leading indicators of future demand, and completions as an indicator of construction capacity.

A growing pipeline of homes under construction should not be interpreted as a sign of strong market conditions. If completions continue to lag behind commencements, the pipeline may simply reflect capacity constraints rather than underlying strength. Higher interest rates will further test the resilience of both demand and the construction pipeline.

How do the forecasts compare?

FWPA’s outlook is broadly consistent with the early-October 2026 AFR economist survey, although it differs from the RBA’s August 2026 projections. The RBA forecasts predate the latest inflation data and subsequent monetary policy developments, which may partly explain the differences.

The main difference concerns the pace of disinflation in 2027. The RBA projects headline inflation to fall to 2.8 per cent by June 2027, returning it to the target band. By contrast, the AFR economist survey projects inflation at 3.2 per cent, suggesting that price pressures could persist for longer.

The AFR survey also points to a stable cash rate, a higher unemployment rate, and weaker economic growth than the RBA’s August projections. Taken together, these forecasts suggest that inflation may prove more persistent than previously anticipated, requiring monetary policy to remain restrictive for longer.

Table 1: Forecast by the RBA and AFR Economist Survey

Sources: AFR, RBA

Economic and Industry Implications

Inflation is expected to take time to return to the RBA’s 2-3 per cent target band. FWPA’s outlook suggests this may not occur until late 2027 or early 2028, later than implied by the RBA’s August projections. High interest rates are expected to weigh on household spending and economic growth, while unemployment is likely to increase slightly. Both the RBA’s projections and the AFR economist survey point to a gradual increase in unemployment, reaching approximately 4.6–4.8 per cent by mid-2027. For businesses, including forest and wood products manufacturers, the key message is to prepare for an extended period of relatively high borrowing costs and softer demand, particularly in housing-related markets. Businesses should continue to monitor residential construction, renovation activity, household spending, and financing conditions when making investment and production decisions.

The outlook remains subject to considerable uncertainty. Changes in global oil prices and future RBA decisions will influence the pace of disinflation and the broader economic outlook. A sustained easing in energy prices or a faster-than-expected moderation in underlying inflation could bring the return to target forward.