The Australian economy expanded at its strongest annual rate in nearly three years during the December quarter, according to data released on Wednesday.

The acceleration has revived inflationary pressures and prompted the need for higher interest rates to help curb demand.

However, the economic outlook has been clouded by escalating tensions in the Middle East, which have disrupted oil shipments through the Strait of Hormuz and driven prices up by more than 10%.

Although Australia is a net exporter of energy, prolonged increases in oil prices function like a cost burden on households and businesses, Reuters reports.

“While stronger growth may seem like positive news, the result will be a concern" for ​the Reserve Bank of Australia (RBA), according to Stephen Smith, partner at Deloitte Access Economics.

“The RBA is already ⁠of the view that the economy is operating above its potential. Combined with elevated inflation, today's data will keep the RBA on ​high alert and increase the likelihood of a rate hike in May.”

Data from the Australian Bureau of Statistics revealed that real gross domestic product increased by 0.8% in the fourth quarter, surpassing the previously revised 0.5% growth recorded in the prior quarter. Analysts had recently raised their projections to around 1.0%.

On an annual basis, growth climbed to 2.6%, marking the strongest performance since early 2023, when the effects of post-pandemic stimulus were still influencing the economy.

The RBA estimates that growth above 2% could fuel inflationary pressures. As a result, it increased interest rates last month by 25 basis points to 3.85% after inflation began to pick up again, following three rate cuts made last year.

Despite the quarterly growth figure coming in below expectations, three-year government bond futures trimmed earlier declines, rising 3 ticks to 95.69. Meanwhile, the Australian Dollar dropped 0.6% to $0.6994 as Asian equity markets declined amid concerns about an expanding conflict in the Middle East.

Market participants continued to price in roughly a 30% chance of a rate increase in March, with a policy tightening fully expected by May.

The stronger-than-expected data highlighted the economy’s resilience in the final quarter, even as it approached capacity limits. Inflation rose to 3.8% in January, while the unemployment rate remained near a historic low of 4.1%. However, the central bank’s recent rate increase in February is expected to help cool demand.

During the quarter, inventory accumulation was the largest driver of growth, contributing 0.4 percentage points. Government expenditure, largely focused on defence, added 0.2 percentage points, while household spending made a modest contribution of just 0.1 percentage point.

The household savings ratio, meanwhile, rose to 6.9% from 6.1%, indicating that consumers still retained considerable capacity to spend.

Inflation indicators stayed elevated, however, a key measure of labour costs eased to its slowest annual growth rate since early 2021.

Furthermore, in nominal terms, GDP surged by 6% in 2025, reaching A$2.85 trillion.