What’s really driving Australia’s economy — and what it means for interest rates in 2026

When people talk about the economy at the moment, the conversation usually centres on households feeling stretched, higher mortgage repayments, and consumers pulling back. And that’s all true — many families are under real pressure.

But according to recent research from Westpac, that isn’t the full story.

Behind the scenes, government and publicly funded spending has become one of the biggest forces supporting Australia’s economy. In fact, Westpac’s economists describe the rise in public spending as one of the largest structural shifts in decades — comparable in scale to the mining boom of the 2000s.

Today, around a third of Australia’s economic output is linked to public spending. This includes infrastructure projects, healthcare, aged care, disability services, education and defence. Importantly, this isn’t just a short‑term stimulus. Westpac sees it as a structural change in how the economy now grows.

This helps explain something many people have found confusing. Despite higher interest rates and weaker consumer confidence, the economy has held up better than expected. Employment has remained relatively strong, and Australia has avoided a sharp downturn. The reason is that while households have been tightening their belts, government‑funded activity has continued to inject demand into the system.

That support has flowed well beyond government departments themselves. Public spending now underpins a large share of jobs across construction, healthcare, professional services and many private businesses that rely on government demand. Over the past decade, this shift has contributed to well over a million additional jobs across the economy.

However, this has important implications for interest rates — especially looking ahead to 2026.

From the Reserve Bank’s perspective, inflation isn’t driven only by how much people are spending at the shops. It’s also influenced by demand for workers, construction capacity and services. When public spending remains strong, it keeps pressure on labour markets and certain sectors of the economy, which makes inflation harder to fully bring back under control.

This helps explain why interest rates have stayed higher for longer than many households hoped. Even though consumers are clearly feeling the strain, the broader economy hasn’t slowed enough to give the RBA confidence to cut rates quickly. As long as public demand continues to support growth and employment, the RBA has to be cautious about easing policy too early.

Looking into 2026, this points to a more measured outlook for rates. We may not see significant further increases, but equally, we shouldn’t assume a rapid return to the ultra‑low interest rates of the past decade. Rates may gradually ease over time if inflation continues to fall and public spending slows — but they are likely to remain at more “normal” historical levels rather than emergency lows.

For households, this means ongoing pressure on cash flow, even if rate rises pause or modest cuts eventually arrive. The bigger adjustment isn’t just coping with higher rates today, but planning for a future where borrowing costs remain meaningfully higher than many people originally expected.

At the same time, continued public spending has helped protect jobs and incomes, which has been an important stabiliser for the economy. The challenge ahead will be timing. If government spending slows before private investment and household spending recover, growth could soften. If public demand stays strong, rates may stay higher for longer.

The key takeaway is this: interest rates in 2026 aren’t just about what households are doing. They’re being shaped by a broader shift in how Australia’s economy is being supported. Understanding that helps explain why the outlook feels uncertain — and why careful, realistic financial planning matters more than ever.

If any of this has raised questions about how higher‑for‑longer interest rates could affect your mortgage, investments, or long‑term plans, we encourage you to talk it through with us. Everyone’s situation is different, and small adjustments can often make a meaningful difference.

You can book an appointment with our team at either our Melbourne office or our Gold Coast office at a time that suits you. If you’re concerned about your personal situation, now is a good time to have the conversation.