SYDNEY (Reuters) -Australia’s monetary policy faces an unusual challenge as the economy began recovering last year with demand still above potential output, a top central bank official said on Monday, suggesting little room for near-term policy easing.

In a speech at a UBS conference in Sydney, Reserve Bank of Australia (RBA) Deputy Governor Andrew Hauser noted that demand was “slightly” above potential output when GDP growth started to pick up last year, the tightest the economy has been in a recovery since the early 1980s.

That implies there is less room to grow the economy without generating inflationary pressures.

“That can still be consistent with bringing inflation back to target over the medium term. But achieving that goal will require policy to be restrictive enough to keep shrinking the gap over that period,” Hauser said.

“The absence of spare capacity is good news: it means busier companies and more jobs...But it does pose challenges for policy setting.”

The RBA left interest rates unchanged at 3.6% last week as a surge in inflation, firmer consumer demand and a revival in the housing market saw policymakers turn more cautious about further easing after three rate cuts this year.

Inflation is now expected to stay above the 2-3% target band until at least mid-2026 as the central bank acknowledged there might be more capacity constraints in the economy than previously thought. Economists from the Commonwealth Bank of Australia and HSBC have called for an end to the current easing cycle, while markets assume only one cut left by mid-next year.

Hauser said the economy needed more supply through boosting productivity and investment in new capacity. The RBA has worried low productivity in the country could generate more sticky inflation.

“If we fail to do so, we may find ourselves boxed in on the rail. If we succeed, we could be off to the races,” Hauser said.