Australia’s economy and market do not appear to be in distress. Offices are full, construction cranes remain on the skyline, and investors have just pushed the stock market to a record high.
Meanwhile, the central bank is raising interest rates, and business leaders are warning that the country cannot keep expanding as it used to.
That tension captures the current moment.
Growth is steady but capped, prices are still uncomfortable, and financial markets are optimistic in a way that demands scrutiny rather than celebration.
Why did the RBA resume tightening?
Earlier this month, the Reserve Bank of Australia lifted the cash rate to 3.85%, becoming the first major central bank this year to raise rates again.
The move came only months after completing a modest easing cycle.
Inflation had slowed from its 2022 peak above 8%, yet it began to reaccelerate late last year.
Headline inflation is running at about 3.7% to 3.8%. Core measures remain above the 2% to 3% target band.
At the same time, the RBA has trimmed its growth forecasts to roughly 1.8% this year and 1.6% next year.
That combination tells you how narrow the policy path has become. Growth is below trend, yet inflation has not returned to target.
Markets expect at least one more increase, with bond yields above 4.3% on three-year government paper.
Policy is restrictive because the economy has little spare capacity. That is the core message from the central bank.
Is productivity the real constraint?
Australia’s labour productivity growth has declined for two decades. It averaged about 1.8% in the early 2000s, and recent figures from the ABS show it closer to 0.8%.
When productivity is weak, the economy reaches inflation limits at lower growth rates.
Wages rise, but output per worker does not keep pace. Businesses face higher costs and pass some of them on.
Senior executives have started saying this openly.
The head of the National Australia Bank warned that without stronger productivity, the country cannot grow much faster than it is today.
The chief executive of Wesfarmers said Australia is close to a tipping point if reform stalls.
The data support their concern. GDP growth is just above 2%, well below the long-run average of 3.3%, even though population growth has been strong.
Though this has to do with lower output per person rather than a collapse in demand.
The inflation problem, therefore, has a structural side. It is not only about spending too much. It is about producing too little per hour worked.
Are households actually worse off?
Wages rose 3.44% in 2025 and inflation came in at 3.76%, which means that real wages dipped slightly over the year.
However, over the past three years, wages have increased 11.33% while inflation totals about 8.5%. Workers are still ahead over that period.
Although the latest data show pressure, it’s not a collapse in living standards.
Unemployment remains around 4.1%.
Employment increased again in January, bringing the total jobs to more than 14.7 million. A tight labour market supports incomes, although it also limits how quickly inflation can fall.
The more subtle issue is that real income gains cannot accelerate unless productivity improves.
Without stronger output per worker, wage growth either slows or feeds back into prices.
What is driving the stock market higher?
While the macro story looks constrained, equities have rallied. The S&P/ASX 200 recently closed at 9,086, breaking through the 9,000 mark. The index is already up 3.5% for the year.
Consensus earnings for FY2026 have been upgraded by about 2.2% during the February reporting period.
Normally, analysts trim forecasts at this stage. Instead, aggregate EPS is now expected to rise roughly 10% in FY2026 and close to that again in FY2027.
That two-year earnings path supports the index even with growth running below trend.
Banks and miners remain central to Australia’s economy and markets.
Major banks delivered stronger credit growth, firmer net interest margins and cost discipline. Loan losses remain contained while unemployment sits near 4%.
On the resources side, modest revenue upgrades translated into much stronger operating and free cash flow growth due to tight cost control.
Capital expenditure guidance has been reduced at some large miners, reinforcing discipline rather than expansion at any price.
There is also a capital return story. Dividends have increased, and buybacks have accelerated, adding to total shareholder yield. In a high-rate environment, that income support matters for valuation.
Valuations are elevated. The market trades near 18 times forward earnings compared with a long-term average closer to 15.
Stocks that miss expectations are falling sharply, often three times more than the rise in those that beat. The market is selective and unforgiving. That is typical when multiples are full.
But the key here is earnings breadth. Defensives have posted strong upgrades alongside cyclicals, which reduces reliance on a single theme and suggests profit momentum is not narrow.
What should investors watch before the next decision?
Core inflation and service price pressures will guide the next move from the Reserve Bank of Australia.
A clear slowdown would stabilise rate expectations. Sticky inflation keeps the tightening bias alive.
Australia is running below trend growth with inflation still above target and equities near records.
Bonds reflect caution. Shares reflect earnings strength. The next phase depends less on sentiment and more on whether profits continue to justify the price.
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