Australia’s Q1 2025 Economic Crossroads: Flat Construction, Sticky Inflation, & Monetary Policy Dilemma

Macroeconomic Landscape – Construction Plateaus Amid Regional Divergence

Australia’s total construction work done in Q1 2025 remained flat at AUD 74.43 billion, failing to meet market expectations of a 0.5% increase and marking a deceleration from the upwardly revised 0.9% gain in Q4 2024 (ABS, 2025a). This stagnation reflects a duality: while building construction and residential housing activity exhibited moderate strength, they were offset by significant contractions in engineering and non-residential work.

Building construction rose by 0.9%, an improvement from 0.1% in Q4, supported largely by sustained urban development and moderate demand in the residential segment, which also grew 1.6%, consistent with the previous quarter. This persistence in housing sector momentum comes despite elevated interest rates, suggesting a lagged effect of monetary tightening or resilience in housing demand due to migration and supply constraints.

On the other hand, engineering construction declined by 1.0%, reversing its 1.7% increase in Q4, reflecting fewer infrastructure starts, cost overruns, and project delays. Non-residential construction marginally fell 0.1%, continuing a downward trend from -2.2% in Q4, signaling weak business investment outside the housing market.

Geographically, a clear state-level divergence is visible. South Australia (6.7%), Western Australia (2.0%), and Queensland (1.5%) recorded positive growth, benefiting from resource-linked investment and government infrastructure projects. Meanwhile, economic heavyweights like New South Wales (-1.3%) and Victoria (-1.1%) witnessed contractions, alongside severe declines in Tasmania (-4.3%), Northern Territory (-21.6%), and the ACT (-2.0%), underlining the uneven national recovery.

Despite the flat quarterly result, annual construction activity rose 3.5% YoY, accelerating from 1.9% in Q4 2024, signaling longer-term resilience driven by public investment and housing policy tailwinds.

Inflation Trends – Sticky Core, Divergent Sectoral Pressures

Australia’s monthly CPI indicator for April 2025 showed headline inflation unchanged at 2.4% YoY, marking the third consecutive month at this level and the lowest since November 2024 (ABS, 2025b). This stability, however, masks meaningful shifts within expenditure categories and raises critical questions for the Reserve Bank of Australia’s (RBA) policy trajectory.

Headline CPI slightly exceeded expectations of a 2.3% rise, with core inflation (trimmed mean) ticking up to 2.8% from 2.7% in March, and CPI excluding volatile items (e.g., fuel, travel) also rising 2.8% YoY (ABS, 2025b). This suggests underlying price pressures are not receding as quickly as hoped, even as fuel and transport costs decline.

Category-wise breakdown reveals divergent inflationary dynamics:

• Cooling sectors: Food and non-alcoholic beverages decelerated to 3.1% (from 3.4%), and alcohol and tobacco to 5.7% (from 6.7%), reflecting base effects and global supply normalization.

• Accelerating sectors: Housing rose 2.2% (vs. 1.8%), fueled by rising rents and utilities. Health costs rose 4.4% (from 4.0%), driven by medical services inflation. Recreation (3.6% vs. 2.7%) and clothing (0.8% vs. 0.7%) also edged higher.

• Transport deflation deepened to -3.2%, as fuel prices plunged -12.0% YoY, the steepest fall in seven months. This deflation offers temporary relief to households but is unlikely to persist given global oil market volatility.

Education costs were flat at 5.7%, reflecting seasonal fee structures. Importantly, goods inflation is easing while services inflation remains sticky—a pattern consistent with other advanced economies.

The interplay of housing cost rises and fuel deflation presents a mixed inflation signal, complicating policy decisions. The RBA now faces a dual risk: tightening too soon and choking growth, or easing too quickly and reigniting core inflation.

Policy Response & Market Outlook – Yield Curve Reacts to Inflation Stasis

The RBA’s recent 25 bps cut, bringing the cash rate to 3.85%, marks its first rate reduction since 2023 and signals a shift toward growth support amid rising global uncertainty and mixed domestic indicators (RBA, 2025). The bank emphasized that inflation was “progressing toward target”, but acknowledged “increasing downside risks” from geopolitical tensions, slowing trade, and subdued investment.

Following the CPI release, Australia’s 10-Year Government Bond Yield rose to 4.31%, ending a three-session decline (Trading Economics, 2025). This uptick suggests markets are cautious about further monetary easing given the stickiness in trimmed mean inflation.

Despite this, bond futures reflect a 65% probability of another rate cut in July 2025, with consensus expectations now pointing to 75 bps total easing by Q1 2026. This reflects market belief that the RBA will prioritize recession avoidance, especially given tepid construction data and global uncertainty.

However, the RBA’s path is complicated:

• The flat construction sector shows demand-side softness.

• Sticky core inflation implies incomplete disinflation.

• A divergent inflation profile (housing up, fuel down) makes a uniform response risky.

Strategic policy implications include the need for targeted fiscal infrastructure programs to revive engineering work, reform in housing supply chains to ease housing inflation, and closer coordination with states to address regional construction disparities.

From a bond market perspective, yield volatility is likely to persist as inflation expectations adjust to incoming data and RBA signals. Investors should expect bond yields to hover in the 4.2%–4.5% range through mid-2025, contingent on the inflation trajectory and geopolitical shocks.

Conclusion: Navigating the “Middle Path”

Australia stands at a critical economic juncture. While inflation is under relative control, underlying dynamics remain complex. Construction activity is regionally fragmented, and policy trade-offs are increasingly acute. The RBA’s cautious easing reflects both progress in taming inflation and anxiety over economic softness. However, the sticky nature of core inflation and rising housing costs mean monetary policy alone cannot guarantee a smooth path forward. Coordinated fiscal, housing, and regulatory responses will be vital in ensuring a durable, inclusive recovery.

Source:

Australian Bureau of Statistics (2025a). Construction Work Done, Australia, March 2025.

Australian Bureau of Statistics (2025b). Monthly CPI Indicator, Australia, April 2025.

Reserve Bank of Australia (2025). Monetary Policy Decision – May 2025.

Trading Economics (2025). Australia 10-Year Bond Yield – May 2025.