Australia’s economy experienced its slowest growth in a year during the last quarter, with rising interest rates and high inflation taking a toll on consumer spending.

While trade contributed positively, without it, the economy would have contracted in the December quarter due to the squeeze on purchasing power from higher prices.

The Australian Bureau of Statistics (ABS) reported a real GDP growth of 0.5% for the December quarter, down from 0.7% in the previous quarter, and below expectations of 0.8%.

The softer-than-expected result led to a brief dip in the Australian dollar and a slight uptick in three-year bond futures.

Annual growth, though still solid at 2.7%, showed signs of underlying cost and price pressures, reinforcing the likelihood of further interest rate hikes by the Reserve Bank of Australia (RBA).

Domestic prices saw their strongest annual increase since the early 1990s, driven by rising labor costs and a shortage of skilled workers, particularly in the services sector.

Another ABS report indicated a 7.4% rise in consumer prices over the year to January, marking the second-highest reading on record, though slightly lower than expected.

These inflationary pressures have prompted the RBA to raise its cash rate by 325 basis points since May, reaching a decade-high of 3.35%, with further increases anticipated.

Mortgage payments surged by 23% in the December quarter, while the household savings rate fell to a five-year low of 4.5%, down from 7.1% in the previous quarter.

The reduction in savings suggests that consumers have a smaller buffer to maintain spending in the coming months, potentially leading to further economic softening.

Household consumption increased by just 0.3% in the quarter, with notable declines in spending on clothing, recreation, and electronics.

Economic output, excluding international trade, actually contracted by 0.5%, marking the first such decline since the pandemic lockdowns.

Westpac senior economist Andrew Hanlan noted that domestic demand stalled in the December quarter, marking the weakest result outside of a lockdown period since June 2014.

The RBA’s aggressive rate hikes appear to be curbing demand, but whether this will be enough to tame inflation without further slowing the economy remains uncertain.

Treasurer Jim Chalmers expressed confidence that the worst of inflation is behind us, though the effects of high borrowing costs are likely to linger.

With rates expected to peak around 4.35% by mid-year, Australia’s economic trajectory will largely depend on how consumers and businesses adapt to these tightening financial conditions.