Sharp growth in defence investment and spending by federal public corporations contributed to a 0.9 per cent rise in public investment in the December quarter, despite a sharp fall in public infrastructure work, Westpac economists said in a research note.
After retreating in the first half of 2025, the strong rebound in public demand, following a 1.3 per cent lift in the September quarter, contradicts Treasurer Jim Chalmers' claims that government spending is not fuelling inflation.
Alongside other stronger-than-expected economic indicators released in recent days, like higher public inventory figures, Westpac's Pat Bustamante, Mantas Vanagas and Neha Sharma revised up their December quarter GDP growth forecast to 1.1 per cent.
If borne out in national accounts figures, set to be released by the Australian Bureau of Statistics on Wednesday, that would represent the nation's highest quarterly economic growth rate since December 2016, outside of the COVID-19 period.
Defence investment rose 7.1 per cent over the quarter and investment by federal public corporations climbed 6.1 per cent, offsetting lower investment from state and local governments.
Experts caution that the budget is better at gauging trends in government spending than public demand data.
But following the RBA's rate hike in February, Dr Chalmers consistently argued public demand's contribution to inflation was falling.
"Cost-of-living support measures have largely come to an end but programs such as the NDIS could continue supporting government spending going forward," the Westpac trio said in the note.
They expect GDP growth ran at 2.6 per cent year-on-year, which would be higher than the Reserve Bank's forecast of 2.3 per cent, included in its Statement on Monetary Policy in February.
Because of Australia's weak productivity growth performance, the RBA estimates that GDP growth higher than about two per cent per year would exceed the economy's speed limit and cause inflation to rise.
In a speech to the Australian Financial Review Business Summit on Tuesday, RBA governor Michele Bullock said demand was outstripping the economy's capacity, causing inflation to run hotter than the central bank was comfortable with.
"The economy's supply potential appears to have been somewhat lower than previously assessed," she said.
Commonwealth Bank economists upgraded their December quarter GDP forecast from 0.7 per cent to one per cent, which would be "well above" estimates of potential.
On top of this, conflict in the Middle East has ignited fears of a dramatic rise in oil prices, which would add more fuel to the inflation fire.
"The RBA is already on edge having lifted the cash rate in February," said CBA's Ashwin Clarke, Harry Ottley and Belinda Allen in a research note.
"A strong finish to 2025 does not shift the outlook but it does suggest the changes the RBA made to its assessment of the output gap were warranted."
That supports their view that the RBA will need to hike rates further to bring the economy back to balance and increases the likelihood that the board could move as early as March 17, they said.
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