Spotlight on Australia - January 2025

Since the end of the COVID-19 pandemic, Australia’s labour market has been surprisingly strong. Even as the RBA increased interest rates and GDP growth slowed, employment growth has kept surprising on the upside (see chart below). In December, the number of employed increased by 65,000, the highest number since April 2025. While the RBA has taken some credit for the strong labour market, with inflation rising again, the still too–strong labour market may now force it to raise rates again, and so soon after it began cutting rates.

The COVID-19 effect

The pandemic has fundamentally changed the Australian labour market, as it has in several other countries. Unemployment is a step down from where it was previously, while the participation rate rose (see the gap between the blue and orange lines in the chart below). History tells us that only a recession or a large negative demand shock, like the Global Financial Crisis, will now shift it higher. Australian unemployment is typically sticky following recessions, the pandemic recession being an exception. 

But not only is unemployment markedly lower following the pandemic, job vacancies also remain unusually high. The Beveridge curve below shows that despite some movement downwards, Australia’s job vacancies remain historically high relative to the unemployment rate.

Source: OECD

The release of pent-up demand following the strict lockdowns in 2020, government stimulus payments, and labour hoarding by employers have all contributed to the strong labour market.

The RBA has landed the plane

After inflation accelerated at the end of 2021, the RBA started raising interest rates in 2022. GDP growth naturally slowed. Nominal wages also increased in response to the rising inflation. Despite these, unemployment has remained stubbornly low and well below government expectations (see chart below).

Source: Parliamentary Budget Office

The post-pandemic resilience of the labour market has allowed the RBA to “land the plane”. In other words, the RBA got inflation under control with lower than expected interest rates and unemployment. The RBA’s performance stands out internationally (see chart below).

Source: Budget Paper No.1, Budget 2025-26

Excess demand still there

In recent months, RBA Governor Michele Bullock and several senior staff members have admitted that aggregate demand may still be stronger than aggregate supply, and that this could be behind the recent uptick in inflation.

“In relation to the output gap, members observed that recent data on inflation and output growth had resulted in a rise in model-based estimates of excess demand.” Minutes of the Monetary Policy Board Meeting 9 December 2025.

Headline inflation eased from 3.8% in October to 3.4% in November, but like a slap in the RBA’s face, it increased back up to 3.8% in December, which was also above expectations (see chart below). This solidifies the narrative that the economy is slightly overheating. 

This excess demand also keeps upward pressure on labour demand and wages.

The RBA will need to raise interest rates soon. Not only to bring the economy closer to balance and to take pressure off inflation and wages, but also to ensure that wages don’t piggyback off inflation.

Unemployment will stay low or may even decrease in the short-term, but as interest rates go back up, we will probably see unemployment rise. However, Australia is unlikely to enter a recession, and so unemployment will not increase significantly.

Final thoughts

In hindsight, perhaps the RBA shouldn’t have cut rates last year. Instead, they could have kept rates higher for longer to take more pressure out of the economy. However, this time last year, inflation and wages had been trending down since December 2023; the data pointed to cuts.

The strong labour market helped the RBA make its soft landing, but now the RBA is hoping to squeeze a little more steam out of the labour market and economy. The plane is lifting off the tarmac a little, but the RBA should still be able to get it back down. Passengers, please keep your seatbelts buckled!