Rate cuts “off the table” for 2026, unemployment to peak mid-year: Oxford Economics Australia
Unemployment to hit 4.6 per cent by mid-2026, up from 4.3 per cent today, with underlying inflation not expected to hit the middle of the target band until 2027
Only a handful of sectors set to do heavy lifting on business investment in 2026, with investment subdued elsewhere
2026 will be the first year this decade in which privately funded engineering construction grows faster than publicly funded work
Monday, January 19, 2026 – The Australian economy ended 2025 in an awkward position: inflation re-accelerated just as rate cuts were expected; growth outperformed but remains unbalanced; and households are fragmented.
According to the Key Themes for 2026 report from leading industry analyst and economic forecaster, Oxford Economics Australia, that sets up a series of tussles for 2026 – inflation versus the RBA, public versus private demand, and homeowners versus everyone else.
How these tensions resolve will shape the outlook for the year ahead.
“Momentum is building in the Australian economy but that doesn’t mean all's rosy for the outlook,” said report author and Head of Economic Research and Global Trade, Harry Murphy Cruise. “Inflation has re-accelerated just when rates were meant to be cut, households are being pulled in different directions, and the drivers of the economy are shifting.”
Inflation is back with a vengeance
Underlying inflation averaged 3.2 per cent y/y in the three months to November, up from a low of 2.8 per cent in June. Headline inflation has climbed more, reaching 3.6 per cent across the last three months. A rebound in goods inflation is doing most of the damage, while services inflation remains stubbornly sticky at just under four per cent.
“The resurgence of inflation caught most forecasters – including us – off guard,” said Murphy Cruise. “As recently as August, both we and the RBA expected trimmed-mean inflation to be comfortably around the midpoint of the target band by year-end. That clearly didn’t happen.”
Source: Oxford Economics, Haver Analytics
Earlier rate cuts gave households a bigger – and faster – spring in their step than anticipated. Households didn’t just respond to the announced cuts; they also began to price in more to come. As expectations of easier policy filtered through, households began to spend the anticipated mortgage repayment savings. Consumption responded first; prices followed.
That demand impulse collided with a second force working against the RBA: administered prices. Electricity, tobacco, childcare fees and local government charges have all risen sharply. These are not prices the RBA can nudge with interest rates. And they're taking up a larger share of the inflation basket.
With inflation back above target and domestic demand surging, rate cuts are off the table for 2026. The question now is whether the Reserve Bank of Australia tightens policy further or plays the waiting game, betting that more time with moderately restrictive rates will be enough to do the job on inflation.
“We think the RBA will choose patience,” said Murphy Cruise. “For starters, the labour market is already showing signs of softening. Working age participation is edging lower, underemployment is drifting higher, and forward indicators such as job ads suggest firms are becoming more cautious about hiring.”
All that suggests unemployment will rise in the coming months, with Oxford Economics Australia expecting it to hit 4.6 per cent by mid-2026, up from 4.3 per cent today. Modelling using Oxford Economics’ Global Economic Model shows that a 30bp increase will deliver roughly the same disinflationary impulse as another rate hike.
“The combination of still restrictive rates and higher unemployment will push underlying inflation down to 2.8 per cent by the end of the year and return to the middle of the target band by 2027,” said Murphy Cruise. “The economy’s recent resilience suggests the current cash rate is less restrictive than we previously assumed. As a result, we’ve raised our estimate of the neutral rate to 3.35 per cent -- from 3.1 per cent.”
An economy divided, with the split running through housing
“House prices surged through the back end of last year, turbocharged by rate cuts and government support measures such as Help to Buy and the expanded five per cent deposit schemes,” said Murphy Cruise. “That rally has delivered a material wealth boost to homeowners.”
Mortgage holders, meanwhile, are telling a very different story. After enduring an extended period of high interest rates, expected relief has evaporated. Market pricing for where rates will end 2026 is now almost 100bps higher than it was six months ago.
These dynamics are visible in consumer sentiment. Confidence among outright homeowners has rocketed higher, while sentiment for mortgage holders is deeply pessimistic – and deteriorating. In fact, the gap between the two ended 2025 at the widest on record in the history of the Westpac-Melbourne Institute survey.
“Renters sit somewhere in between,” said Murphy Cruise. “Slowing rent growth has provided some breathing room, but rapid house price gains continue to push ownership further out of reach. Without state and federal government demand-side policy support, confidence for this group would be even weaker.”
These divides will shape consumption through 2026.
Outright owners – buoyed by rising housing wealth – will splurge on the nice-to-haves, particularly through the first half of the year when price gains are strongest. Mortgage holders and renters, who together account for roughly 70 per cent of household consumption, will be more constrained. As a result, aggregate household spending growth will likely be less spectacular than some recent commentary suggests, although it should continue to chug along.
Housing isn’t the only fault line in the economy
“Business investment is becoming increasingly polarised,” said Murphy Cruise. “Data centres are on a winning streak, particularly in Western Sydney and Melbourne. These cities are emerging as global hubs thanks to a rare mix of political stability, subsea cable connectivity, renewable-energy capacity, and access to skilled labour.
“To date, much of the pipeline has been geared towards cloud computing. That’s changing, with AI-driven demand set to become a more important driver through 2026.”
All that investment has spillover benefits to other sectors. Data centres are extraordinarily energy-intensive, requiring a solid pipeline of renewable generation, transmission upgrades, and storage investment. At the same time, mining investment is rebounding after a period of weakness.
Outside these sectors, investment remains subdued. High construction costs, lingering policy uncertainty, and fractured consumer demand are all weighing on firms’ willingness to commit capital. Those dynamics will continue into 2026, with only a handful of sectors doing the heavy lifting.
The public sector will hand the baton to the private sector
In 2024, public demand contributed roughly twice as much to economic growth as the private sector. That imbalance began to unwind in 2025, even though public spending remained near a record 28 per cent of GDP.
“We expect that contribution to ease further through 2026,” said Murphy Cruise. “This year will mark the first year this decade in which privately funded engineering construction grows faster than publicly funded work.”
That's important for two reasons. First, an outsized public pipeline creates capacity constraints. When governments and firms chase the same labour and materials, costs rise, inflation lifts, and interest rates stay higher for longer.
Second, productivity has floundered in recent years. Part of that reflects a compositional shift in the economy. Health care, aged care, and public administration have expanded rapidly, while market-sector activity has lagged. These sectors are essential, but they tend to deliver lower measured productivity growth than private, capital-deep industries.
Source: Oxford Economics
A gradual rebalancing towards private-sector-led investment, particularly in energy, mining, and technology-related infrastructure, offers a pathway back to stronger productivity outcomes over time.
“It's not a silver bullet, nor will the transition be seamless; labour shortages remain acute, and capacity constraints won’t disappear overnight,” said Murphy Cruise. “But the direction of travel matters. A growth model led by private investment, rather than ever-larger public outlays, is ultimately more sustainable, more productive and more wealth-creating.”
About Oxford Economics Australia
Oxford Economics Australia, formally known as BIS Oxford Economics, is Australia's leading provider of industry research, analysis and forecasting services. Following the acquisition of BIS Shrapnel in 2017, Oxford Economics Australia now has unparalleled capabilities in helping clients to understand issues across over 100 sectors at the granular local area through to the global economy. This analysis is underpinned through robust economic models that are fed by reliable and most importantly detailed market data, analysis of developments, and thoroughly researched forecasts.
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