The Reserve Bank of Australia said it will have to raise interest rates further as unemployment is expected to fall to its lowest level since 1974, fueling wage growth and supporting consumer price growth.

Headline and core inflation are expected to remain above the 2-3% target this year and next year before falling back to 2.9% at the end of the forecast period in June 2024, the RBA said in its monetary policy statement on Friday. The cash rate is assumed to be 1.75% at the end of the year and 2.5% at the end of next year, he said.

“Rising labor costs in response to a tight labor market are expected to become the main driver of inflation outcomes later in the forecast horizon,” the RBA said. Companies “now say they are either paying larger wage increases or expecting materially higher wage growth in the coming year.”

Australia’s economy is booming in response to fiscal and monetary stimulus during the pandemic and, like much of the developed world, policymakers are grappling with a spike in inflation. The central bank raised rates 25 basis points higher than expected on Tuesday as Governor Philip Lowe adopted a more hawkish outlook ahead of the Federal Reserve’s half-point hike.

Economists expect the bank to continue climbing this year, with Goldman Sachs Group Inc. predicting the benchmark will be 2.6% by year-end. The RBA expects the economy to expand by 4.2% this year, to reach 2% by the end of 2023, as reduced stimulus weighs on growth, the quarterly update showed.

Unemployment is estimated at around 3.5% at the start of 2023, the lowest level since 1974, and remains “around that level thereafter”, the bank said. He said reopening the border could ultimately help ease labor shortages in some industries, while increasing demand in the economy.

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

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

Still, he said, high commodity prices resulting from the conflict will boost national income in Australia and will likely see the terms of trade hit a new high in the first half of this year.

Bloomberg