Inflation is no longer expected to return to the midpoint of the Reserve Bank's two to three per cent target range in the foreseeable future, due to unexpected tightness in the labour market.
The central bank updated its economic forecasts on Tuesday, as the board cut rates for the first time in more than four years.
While a surprise drop in underlying inflation in the December quarter is expected to bring it down to the target range earlier than expected, a pick-up in domestic activity will keep the labour market tighter than previously thought.
"The easing in the labour market that had been under way since late 2022 has stalled and some key indicators suggest that conditions tightened a little in late 2024," the bank said in its Statement on Monetary Policy.
Consequently, underlying inflation would remain at 2.7 per cent until at least June 2027, when the bank's forecast ends, assuming the cash rate follows market predictions and drops to 3.6 per cent by the end of 2025.
In November, the RBA predicted underlying inflation to return to 2.5 per cent by the end of 2026.
However, the bank noted there was a risk it was overestimating the non-accelerating inflation rate of unemployment - the lowest unemployment rate that can be sustained without causing wages to grow and inflation to rise.
The unexpected fall in inflation towards the end of 2024 could imply that the labour market had come back into balance and that the current unemployment rate of 4 per cent was not contributing to inflation.
Australia's economic growth is expected to accelerate in 2025 to 2.1 per cent, following weaker-than-expected GDP growth in 2024.
The RBA noted a high degree of uncertainty surrounding the global economic outlook, and much would depend on the extent of tariffs imposed by US President Donald Trump and the response of other governments around the world.
The bank's central scenario foresaw a relatively minor 0.2 per cent reduction to Australian GDP over 12 months.
"While this may be a surprising result, particularly given the very weak global backdrop … this reflects the significant role the exchange rate tends to play in offsetting external shocks to trade for Australia," the statement said.
The RBA also upgraded its expectation for growth in China's economy to 4.7 per cent in 2025.
As a result, the increased demand for Australian exports would provide a boost to Australia's economy that would broadly cancel out the downside risk of a looming trade war.
