IMF warns RBA may need to hike again, urges Australian spending cuts

The IMF's caution bolsters what financial markets are already anticipating, with an RBA rate rise as soon as September 29 priced in, and it offers a marginal uplift to the Australian dollar given the fund is pointing to upside inflation risks rather than downside growth concerns as the main issue. For the Aussie, the more significant near-term influence is energy costs rather than the IMF's statement, especially with Brent crude jumping 35% since early August due to the escalating Middle East conflict, which the IMF warns could push the RBA into action through second-round inflation effects. With the Fed having also just raised rates, a hawkish move by the RBA would align Australia with a global tightening trend, a supportive factor for AUD crosses funded in currencies where central banks are nearing the end of their cycles.

The IMF is urging Australia to tighten fiscal policy and remain prepared to raise rates further, with climbing fuel prices driving much of that message.

Key points:

• The IMF says the RBA should be prepared to hike rates further due to persistent underlying inflation and uncertainty about how restrictive current policy is.
• The IMF projects Australian GDP growth of 1.9% this year, easing to 1.6% in 2027, a downgrade linked to the higher probability of another RBA hike.
• A key risk identified: further increases in global energy prices could trigger second-round inflation effects, necessitating more tightening.
• Brent crude has surged 35% since early August to above $108 a barrel on Wednesday due to the worsening Middle East conflict; Australian core and headline CPI already exceeded forecasts in July.
• Markets are pricing about an 80% chance of a 25bp RBA hike at its September 29 meeting, with some estimates up to 87% and the cash rate hitting 4.85% by early 2027.
• The IMF also called on federal and state governments to reduce spending, while mostly backing Labor's changes to investor taxes; mission chief Paulo Medas said the changes create more balanced incentives that could improve housing affordability.

The International Monetary Fund said on Thursday that Australia's central bank might need to increase interest rates further, cautioning that persistent underlying inflation and uncertainty about whether financial conditions are restrictive enough mean the Reserve Bank of Australia should be ready to hike when necessary. This warning came in the IMF's concluding statement after its annual consultations with the Treasury, the RBA, and the Australian Prudential Regulation Authority.

The fund cut its forecast for Australian economic growth, now projecting an expansion of 1.9% this year before slowing to 1.6% in 2027, a reduction of 0.1 percentage point from its earlier outlook. It linked the downgrade to the increased likelihood of another RBA rate rise. Inflation remains a key challenge, the IMF said, while weak productivity growth is dampening the economy's potential. The fund highlighted a particular risk that further substantial increases in global energy prices could lead to stronger second-round effects, boosting inflation expectations and requiring additional tightening from the RBA, which targets inflation in the 2%-3% range.

That risk is not just theoretical. Fuel prices in Australia are climbing again as the deteriorating Middle East conflict pushed Brent crude above 108 US dollars a barrel on Wednesday, a 35% jump since the start of August. Australian consumer prices already rose more than expected in July as fuel costs increased, with core inflation also exceeding projections. Financial markets are pricing in around an 80% likelihood that the RBA lifts its 4.35% cash rate by 25 basis points at its September 29 meeting, with some estimates placing the probability as high as 87% and seeing the cash rate reach 4.85% by early 2027. The Federal Reserve's rate increase on Wednesday night, its first since 2023, adds to the global tightening environment the RBA is considering.

Alongside its rate warning, the IMF urged Australia's federal and state governments to cut spending, arguing that more disciplined budgets would help control rising debt and support the battle against inflation. The assessment is a setback for treasurer Jim Chalmers, who is already facing pressure to deliver a convincing story on living standards and prosperity. The fund did, however, largely support the government's changes to investor tax settings, while noting some concerns about unintended consequences. IMF mission chief Paulo Medas said earlier consultations had identified Australia's property tax arrangements, including negative gearing, as encouraging households to take on more debt and invest in housing, adding to price pressures. He said the government's budget changes had created a more balanced set of incentives that could channel more investment toward other parts of the economy, calling it a positive change to the tax system that could help with housing affordability.

Another hike before the year ends is not out of the question given persistently high inflation.