Australia's economic slowdown is just beginning, economists warn, as recession risks rise

Australia's economic slowdown is just beginning, economists warn, as interest rate rises and cost-of-living pressures weigh on households.

The economy grew just 0.3 per cent in the first quarter of 2026, the Australian Bureau of Statistics revealed on Wednesday, but the figures only captured the first month of the Middle East war.

"Surging inflation, sky-high oil prices and shattered confidence will collide to crimp spending through the rest of the year," Oxford Economics Australia's head of economic research and global trade, Harry Murphy Cruise, wrote.

Gross domestic product (GDP) per capita went backwards in the quarter, down 0.1 per cent, in the first contraction since the start of 2025.

"We expect per capita household spending to be broadly flat in 2026, while softer hiring will push unemployment close to 5 per cent through 2027," Mr Murphy Cruise said.

Recent data showed the unemployment rate rising in April, to 4.5 per cent, meaning Oxford Economics sees a significant weakening in the jobs market from here.

The slowdown in economic growth from the final quarter of last year to the first quarter of this year and the rise in the unemployment rate come as the Reserve Bank battles to get inflation under control.

Inflation was already above the RBA's 2–3 per cent target band before the oil shock caused by the Iran war put further pressure on prices.

"We expect inflation to be with us for a while. Higher interest rates are expected to slow the economy and lower the risk that inflation becomes entrenched," RBA board member Ian Harper remarked earlier this week.

Recession risk rises

HSBC expects weaker demand to filter through the entire economy in the coming months.

"Our view, since March, has been that GDP is likely to contract in Q2 [the three months to June]," HSBC chief economist Paul Bloxham wrote.

Two consecutive quarters of the economy contracting would constitute a so-called technical recession.

Mr Bloxham does not see inflation returning to the midpoint of the RBA's target band without a prolonged economic downturn.

"With inflation well above target and growth having been well above potential — given very weak productivity growth — we see the only likely pathway to getting inflation down over a reasonable time frame is to push the economy into a downturn.

HSBC believes this downturn is "already underway".

Productivity 'a massive drag': AMP

Part of the problem, economists say, is that productivity is no longer just weak; it has gone backwards.

One measure of productivity, GDP per hour worked, fell 0.6 per cent in the quarter and was up just 0.3 per cent over the year.

"This is a massive drag on the economy as it reduces our potential to grow (it impacts our 'speed limit' and therefore dampens living standards)," AMP deputy chief economist Diana Mousina said.

AMP puts the odds of an Australian recession in the next 12 months at 30 per cent.

"Lower consumer spending, lower exports and then business investment down, but a lot would need to go wrong [for it to tip the economy into a technical recession]," she said.

"[You] could also have low growth in everything, then something weird happens in inventories, and you get negative growth."

RBA rate rise risk remains despite slowdown

AMP has said inflation is sufficiently high and productivity sufficiently low to see the RBA hike rates twice more by the end of the year.

Other forecasters, including RBC Capital Markets, see one more interest rate rise.

Further rises would be in addition to three cash rate increases so far this year, in February, March and May.

Those hikes have already had a dampening effect on economic growth, and further increases could be too much for the economy, according to the Commonwealth Bank's economics team.

"By the time we get to the next live meeting, which is in August, we are expecting signs of that slowdown to continue to accelerate," CBA head of Australian economics, Belinda Allen, said.

On Tuesday, Professor Harper, speaking in his capacity as a member of the RBA's monetary policy board, reaffirmed the central bank's commitment to bring down inflation.

"You can see from the bank's forecasts that we're not expecting the underlying rate of inflation to be back into the target band until 2027 and not back to the midpoint until 2028," he said.

"The decision is made under uncertainty. Well, none of us really knows. We're taking our best guess here. We're advised by the bank. We make our own judgement. It's made under uncertainty."

The detail of the GDP data indicated that Australian households, after building their savings, were now beginning to draw them down.

"Households had been steadily rebuilding their buffers, with the savings ratio climbing from the pre-COVID lows of under 2 per cent," RBC Capital Markets noted.

The household savings rate fell from 7 per cent in the December quarter to 6.2 per cent in the March quarter.

It coincided with slowing growth in disposable income as Australians faced rising costs of essentials.

Household spending on essential goods and services increased by 0.8 per cent, while discretionary spending rose by 0.1 per cent in the quarter, the ABS said.

Data centres drive investment

A bright spot in the quarter was Australia's new-found enthusiasm for investment in data centres, which began to show up in the numbers last year.

In the first quarter of this year, private investment grew 3.6 per cent.

This was led by machinery and equipment (+16.3 per cent), with increased business investment in data centres across New South Wales and Victoria.

The fly in the ointment was that the 1.4 per cent increase in imported goods, spurred by record imports of automatic data processing equipment to fit out those same data centres, contributed to net trade, detracting from GDP.

Even considering "the high import intensity of data centre investment", Westpac economists estimated the net effect of the boom drove all of the economic growth in the quarter.