By Jacob Shteyman in Canberra

The Reserve Bank of Australia may need to raise interest rates if the “significant” risk inflation stops falling eventuates, the International Monetary Fund warns.

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”, the global economic body said in its latest assessment of the strength of the Australian economy.

“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 IMF said on Tuesday

The Reserve Bank needed to be supported by non-expansionary fiscal policy that complements its objectives in bringing down inflation, it said.

“Expenditure rationalisation at all levels of government” could reduce the heat in the economy and bring price growth back to target quicker.

Treasurer Jim Chalmers said the IMF backed his 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 nation’s 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.

The RBA is predicted to start cutting interest rates in early 2025, following a dovish tilt by the bank’s board at its last meeting, when it left the cash rate at 4.35 per cent.

Bonds traders are optimistic the central bank will lower the cash rate to 4.10 per cent at its next meeting in February, with the money market implying an almost three-quarters chance of a 25 basis point cut.

The minutes from the December meeting, released on Tuesday, could reinforce that view.

“The meeting minutes will likely sound dovish in line with the statement and be watched for more details around scenarios in which future financial conditions might need to be less restrictive,” IG markets analyst Tony Sycamore said.

Businesses are predicting a modest tick-up in sales this holiday period and will be watching 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.”

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.

“The IMF has endorsed our efforts to make our economy more competitive, dynamic and productive, like our historic shake-up to Australia’s merger settings,” Dr Chalmers said.

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