The Reserve Bank of Australia says it will soon be able to start cutting interest rates, assuming data continues falling in its favour.
The welcome indication, flagged in the central bank board's December meeting minutes, does though come as the International Monetary Fund warns the RBA may need to raise interest rates if the "significant" risk that inflation stops falling eventuates.
In discussions leading to their decision to leave the cash rate on hold at 4.35 per cent, board members said demand in the Australian economy was still too strong but the estimated gap between supply and demand was narrowing.
Slowing growth in wages showed the labour market may not be as tight as assumed and weaker-than-expected housing costs pointed to a modest downside risk in the bank's December quarter inflation forecasts.
Australia's underlying inflation remains higher than the RBA's target of 3.5 per cent. (Joel Carrett/AAP PHOTOS)
While underlying inflation was still higher than the RBA's target at 3.5 per cent, "the risk inflation returns to target more slowly than forecast had diminished since the previous meeting and the downside risks to activity had strengthened.
"If the future flow of data continued to evolve in line with, or weaker than, their expectations, it would further increase their confidence that inflation was declining sustainably towards target," the minutes read.
"If that were to occur, members concluded that it would, in due course, be appropriate to begin relaxing the degree of monetary policy tightness."
Bonds traders are optimistic the central bank will lower the cash rate to 4.10 per cent in February, with the money market implying an almost three-quarters chance of a 25 basis point cut.
The IMF said the central bank was on the right track with its restrictive monetary policy settings but "should be prepared to tighten further if upside inflation risks materialise".
"Inflation is anticipated to sustainably return to the RBA's target range only by the end of 2025, while a potential stall in disinflation poses a significant risk," the global economic body said in its latest assessment of the strength of the Australian economy.
The Reserve Bank needed to be supported by non-expansionary fiscal policy, it said.
Reining in spending at all levels of government could lower the temperature of the economy and bring price growth back to target quicker.
Treasurer Jim Chalmers believes the IMF report shows the Australian economy is in good shape. (Lukas Coch/AAP PHOTOS)
Treasurer Jim Chalmers said the IMF backed the government's responsible economic management.
"Our approach has been to maintain a primary focus on inflation and the cost of living without ignoring the risks to growth and the IMF supports this strategy," he said.
The IMF said Australia was still on track for a soft landing, although risks were tilted to the downside.
Growth in the national economy is expected to pick up from a dire 1.2 per cent in 2024 to a still sluggish 2.1 per cent in 2025.
Unemployment, still historically low at 3.9 per cent, is expected to rise gradually to 4.5 per cent.
Weaker-than-expected growth or a faster-than-projected increase in unemployment could prompt the Reserve Bank to lower interest rates sooner, the IMF said.
Businesses are predicting a modest up-tick in sales this holiday period and will watch the RBA with interest, said Australian Retailers Association chief industry affairs officer Fleur Brown.
"Interest rates are everything when it comes to consumer confidence," Ms Brown told AAP.
"That's critically important for many small businesses in particular, who've really just been hanging in there by a thread."
Retailers say interest rates and consumer confidence are tightly linked. (Diego Fedele/AAP PHOTOS)
Over the medium-to-long term, the IMF urged Australian governments to undertake broader tax and expenditure policy reforms to address budget deficits and promote economic efficiency.
It recommended phasing out the capital gains tax discount and reducing the reliance on direct taxes, like personal income tax.
Efforts to rejuvenate Australia's productivity growth should also be prioritised, including through better competition policy, improving opportunities in AI and boosting research and development, the IMF said.