“Higher labour costs in response to a tight labor market are expected to become the primary driver of inflation outcomes later in the forecast period,” the RBA said. Firms are “now reporting that they are paying larger wage increases or that they expect materially higher wages growth over the coming year.”

Australia’s economy is surging in response to fiscal and monetary stimulus during the pandemic and, like much of the developed world, policy makers are grappling with an inflation outbreak. The central bank raised rates by a larger-than-expected 25 basis points on Tuesday as Governor Philip Lowe pivoted to a more hawkish outlook, just ahead of the Federal Reserve’s half-point hike.

Economists expect the bank to keep hiking this year, with Goldman Sachs Group Inc. forecasting the benchmark will be 2.6% by year’s end. The RBA forecast the economy will expand 4.2% this year, easing to 2% at the end of 2023 as the reduction of stimulus weighs on growth, the quarterly update showed.

Unemployment is seen at around 3.5% in early 2023, the lowest level since 1974, and remain “around that level thereafter,” the bank said. It said reopening of the border could, in time, help alleviate labor shortages in some industries, while also adding to demand in the economy.

“The expansion is likely to be driven by robust consumption growth as spending on discretionary goods and services continues to recover, underpinned by strong household balance sheets and high real household disposable income, despite rising prices,” the RBA said.

The central bank highlighted that China’s lockdowns to combat the coronavirus will add to existing pressures on global supply chains, while Russia’s war on Ukraine remains a major source of uncertainty.

Still, it said, the resulting high commodity prices driven by the conflict will boost national income in Australia and probably see the terms of trade reach a new peak in the first half of this year.

The RBA highlighted other risks to the outlook:

• the future evolution of Covid-19;
• changes in wages and price-setting behavior at historically low levels of unemployment; and
• the responses of households, firms and asset prices to higher inflation and interest rates

It said the board is not currently planning on selling the government bonds purchased during the pandemic. BM