Australian Economy

Outlook | Statement on Monetary Policy – February 2024

Summary

  • Most advanced economy central banks judge their policy rates to be
    restrictive and expect inflation to return to target over the next year or
    so.
    Global growth is expected to be soft over the next two years,
    contributing to slower growth in demand for Australian goods and services.
  • Economic growth in Australia is expected to remain subdued in the near term
    as inflation and higher interest rates continue to weigh on demand.
    The
    forecast for GDP growth is softer than three months ago, largely reflecting a weaker
    outlook for household consumption in the near term. From late 2024, growth is
    expected to pick up gradually as inflation declines and the pressures on household
    incomes ease.
  • Conditions in the labour market are expected to ease further to be broadly
    consistent with full employment in the next couple of years.
    Nominal wages
    growth is expected to remain robust in the near term and then gradually ease.
  • Inflation continues to moderate and is expected to return to the target
    range of 2–3 per cent in 2025 and reach
    the midpoint in 2026.
    The forecasts are based on the technical assumption
    that the cash rate will remain around the current level until the middle of 2024.
    Inflation is anticipated to decline a little quicker than previously thought,
    because goods price inflation has declined more than expected and domestic demand is
    also a little softer than previously anticipated. But, services inflation remains
    high and is still expected to decline only gradually as demand moderates and growth
    in labour and non-labour costs ease.
  • The risks to the domestic outlook are broadly balanced, though the costs
    associated with these risks differ.
    The key risks are: (i) demand could be
    softer than expected, leading to costs to our full employment objective, though
    inflation would decline faster than expected in this case; and (ii) inflation could
    take longer to return to target than anticipated, which would be costly (in terms of
    both the employment and inflation objectives) if this led to inflation expectations
    drifting upwards.

3.1 Global outlook

Global growth is expected to be below average and inflation to decline to be consistent with
central bank targets in many economies.

Year-average GDP growth in Australia’s major trading partners is expected to
ease in 2024, contributing to weaker growth in demand for Australian goods and
services.
This overall outlook is little changed from three months ago, with
stronger forecast growth in the United States and high-income economies in east Asia offset
by weaker growth in some other advanced economies (Graph 3.1).

Graph 3.1



Graph 3.1: A three-panel bar graph showing current and previous year-average GDP growth forecasts for Australia’s major trading partners (MTP) for 2023, 2024, 2025. The first panel shows MTP forecasts in aggregate, which are little changed since the last round and show growth is forecast to be slower in 2024 and 2025 (compared to 2023).  The second panel shows G7 economies (PPP-weighted), where growth is forecast to slow substantially in 2024 (though a little less than previously forecast), before recovering in 2025. The last panel shows forecasts of China’s growth, which is expected to slow over the forecast horizon.

Central banks are generally forecasting that inflation in advanced economies will
decline to be consistent with central bank targets over the next year or so, though flag
upside risks.
This expectation of a decline in inflation is alongside expectations
of softer economic growth and a moderate easing in labour markets. Reflecting this, market
expectations are that policy rates have peaked (see Chapter 1:
Financial Conditions
). In particular, GDP growth in advanced economies is forecast
to slow substantially this year, partly reflecting the effects of tighter monetary policy on
demand. In most G7 economies, private sector economists’ forecasts of growth for
2024 are well below the average growth of the decade prior to the pandemic, although US
growth is expected to slow only moderately. Overall G7 economic growth is forecast to
pick up moderately from the latter half of 2024 and is expected to be supported by less
restrictive monetary policy settings in a number of economies.

Growth in China is expected to slow over the next two years as the rebound
in services consumption fades and the property sector remains weak. Weakness in these
sectors is expected to be partly offset by continued strength in manufacturing investment
and further policy support for infrastructure investment.

Risks to the outlook for global economic growth are tilted to the downside.

  • Key risk #1: Inflation may not decline as quickly as expected, even as demand
    slows further, leading to more restrictive monetary policy and softer global economic
    growth than anticipated.
    Recent progress towards inflation targets has been
    faster than expected in some economies, but services inflation – which remains a
    key focus of many central banks – has eased only gradually and may remain
    stubbornly high. Recent disruptions to global shipping routes pose an additional modest
    upside risk to global inflation and downside risk to growth; this risk could become more
    material in the event of a significant escalation of the conflict in the Middle East.
  • Key risk #2: It remains uncertain how much further the earlier tightening in
    monetary policy will weigh on economic activity.
    Recent further progress
    towards central bank inflation targets has reduced the likelihood that additional
    monetary policy tightening will be required in major advanced economies. However, lags
    in monetary policy transmission mean uncertainties remain (in both directions) about the
    full impact on economic activity of the tightening that has occurred to date.
  • Key risk #3: Economic growth in China could slow more than forecast due to
    continued weakness in the property sector and weaker-than-anticipated household
    consumption.
    Demand for housing in China remains weak despite further policy
    measures to support the sector. A deeper and more prolonged contraction in the property
    sector could weigh more heavily on household consumption, particularly if consumer
    confidence remains subdued and further policy support is limited. If weakness in Chinese
    demand were to compound the effects of soft demand from advanced economies, this could
    weigh on exports (and so economic growth) of other trade-exposed economies in east Asia.

3.2 The domestic outlook

Economic growth is expected to remain subdued in the near term as inflation and earlier
interest rate increases weigh on demand.

The near-term outlook for GDP growth has been revised down modestly from three months
ago, reflecting a weaker outlook for consumer spending.
The soft outlook for GDP
growth in the near term reflects subdued domestic final demand growth (Graph 3.2). The
pressure on household budgets from declines in real incomes over the past couple of years is
expected to weigh on consumption, particularly in the first half of 2024. High construction
costs and ongoing capacity constraints – reflecting shortages for skilled trades
– are forecast to continue weighing on new building approvals and dwelling investment.
Growth in non-mining business investment and public investment is forecast to soften from
the high rates seen over the past year. However, the level of investment is expected to
remain high, as firms continue to work through the large pipeline of construction work.
Strong population growth – driven by growth in international students – and the
continued recovery in inbound tourism is expected to support domestic activity in the near
term and provide some offset to weak spending by Australian residents.

While growth in demand has slowed, the level of demand is
still robust and is assessed to be above the economy’s capacity to supply goods and
services, thereby creating inflationary pressures
(discussed further below). The
forecast period of subdued growth relative to trend is expected to help bring demand and
supply in the economy back into balance.

Graph 3.2



Graph 3.2: A line graph showing the year-ended GDP growth forecast within the RBA’s 70 and 90 per cent historical forecast error bands. It shows GDP growth declining in the near term before rising to around 2½ per cent by end 2025. The 90 per cent error band spans from around zero to around 5 per cent at end 2025.

The forecasts are based on the technical assumption that the cash rate is around its peak in
the current cycle and will remain around this level until the middle of 2024; the cash rate
path is based on financial market pricing and a survey of market economists (see Table 3.1: Detailed Forecast Table for more information).
While high inflation affects all households and businesses, monetary policy tightening
affects the cash flows of groups of households in different ways. Our assessment is that
most of the two-fifths of households that have a mortgage are well placed to manage mortgage
rates around their current levels, by continuing to curtail spending, saving less or drawing
down on savings buffers.
But, around 5 per cent of borrowers are currently estimated to have insufficient
income to meet their most essential expenses and mortgage payments, and so are drawing down
on savings or finding other ways to increase their income or reduce expenditure. Some of
these borrowers are at risk of depleting their buffers within six months, which would see
them fall behind on mortgage payments. Conversely, households that are net savers are
benefiting from higher interest earned. The other channels of monetary policy are also
working to slow the growth of demand and contributing to the decline in inflation, such as
by increasing incentives to save and by supporting the value of the Australian dollar.

GDP growth is forecast to pick up gradually from later this year, largely reflecting
stronger growth in household consumption and public demand.
Household consumption
growth is forecast to pick up to around its pre-pandemic average over the next year or so,
supported by a recovery in real income growth as inflation continues to moderate (Graph 3.3).
The household saving ratio is expected to decline further in the near term before increasing
gradually from mid-2024 as real income growth turns positive. Dwelling investment is
forecast to increase from 2025 onwards as earlier strong population growth and higher prices
for established housing lead to a pick-up in demand for new housing. The forecasts for GDP
growth beyond the near term are broadly similar to three months ago.

Graph 3.3



Graph 3.3: A two panel line chart showing year-ended forecasts for real consumption and disposable income growth, as well as the saving ratio. It shows that the forecast for consumption growth is subdued in the near term before increasing gradually from mid-2024 as real income growth turns positive. The chart also shows that the household saving ratio is expected to decline a little in the near-term before increasing gradually from mid-2024.

Labour market conditions are expected to ease further to be broadly consistent with full
employment in the next couple of years …

Employment is expected to increase further, but at a slower pace than last
year.
Much of the labour market adjustment to subdued growth in economic activity
is expected to occur through a decline in average hours worked. But employment growth is
also forecast to slow and to be below growth in the working-age population for a time. The
rate of participation in the labour force is expected to decline a little over the forecast
period as conditions soften, but it is expected to remain at a high level. (Changes in the
assumption for growth in the working-age population have been small relative to the large
upward revisions that occurred last year because of stronger-than-expected net overseas
migration.)

Labour underutilisation rates are expected to rise as employment growth moderates and
average hours worked decline.
Both the broader hours-based underutilisation rate
(i.e. people working fewer hours than they want) and the unemployment rate have increased
since late 2022 when labour market conditions were very tight, and a further increase is
expected over coming quarters in response to slower economic growth (Graph 3.4). That
said, the underutilisation rates forecast over the next few years are well below the typical
rates of the past five decades.

The labour market forecasts are broadly consistent with a return to full employment
conditions that can be sustained over time without adding to inflationary
pressures.
It appears that the economy will be able to sustain lower levels of
labour underutilisation than were typically seen over the past five decades. The assessment
of the labour market relative to full employment is based on a broad range of indicators,
models and judgement (see Chapter 4: In
Depth – Full Employment
for more detail).

Graph 3.4



Graph 3.4: A two-panel graph showing the unemployment and hours-based underutilisation rates gradually increasing over the forecast horizon to around 4½ per cent and 6¼ per cent respectively. It also shows that both the unemployment and hours-based underutilisation rates forecast are lower than the rates typically experienced over the past two decades. The 90 per cent confidence interval around the forecast of unemployment in June 2026 spans from around 2½ per cent to around 6½ per cent.

… leading to a gradual easing in nominal wages growth.

Nominal wages growth is expected to remain robust in the near term, and then decline
gradually in line with the easing in the labour market.
Wages growth has already
begun to moderate in some parts of the private sector and the moderation is expected to
deepen and broaden out over the coming year (Graph 3.5).

Graph 3.5



Graph 3.5: A line graph showing year-ended growth in average earnings per hour and the Wage Price Index since 2005. It shows that average earnings are expected to grow more strongly than the Wage Price Index over the next couple of years.

The recent increase in real wages is expected to continue over the next couple of
years
; nominal wages are expected to increase at a faster pace than inflation
(Graph 3.6).

Graph 3.6



Graph 3.6: A line graph showing average earnings per hour and the wage price index in real terms, indexed to 100 at March 2005. It shows that, in real terms, average earnings per hour is expected to grow at a stronger rate than the Wage Price Index in coming years.

Growth in broad measures of labour costs is high because
recent labour productivity outcomes have been weak.
Recent growth in nominal unit
labour costs – the measure of labour costs that matters most for inflation – has
been at the highest rate since 1990 (excluding pandemic-impacted outcomes in 2020). Growth
in unit labour costs is expected to slow gradually over the next few years.

The forecasts for nominal wages growth remain consistent with the inflation target,
provided labour productivity growth returns to around long-run averages
; this
assumption is embedded in the forecasts. While productivity growth is difficult to forecast
and there are risks that productivity will be weaker than anticipated (see 3.3 Key
risks to the domestic outlook
), much of the recent weakness in productivity has been
a by-product of the pandemic and the economic cycle and will likely unwind over the next few
years. For example:

  • The strong labour market has drawn in new workers and allowed others to change jobs more
    easily. This boost to employment is a good social and economic outcome, but it requires
    a transition period as people are trained in a new role. In time, job mobility can boost
    productivity through the benefits of better matching of people’s skills with jobs.
  • Some industries that faced capacity challenges in recent years, partly related to the
    pandemic and weather disruptions, could see an improvement in productivity as these
    challenges dissipate. For example, activity in the construction industry has been
    hampered by shortages that have led to delays in the way work is completed. But the
    improvement in the availability of materials and skilled labour is gradually reducing
    delays. In some industries – such as tourism– capacity has been insufficient
    to meet demand given the lags for firms (such as tourism operators) to re-establish
    infrastructure and resources, after a period of low demand.
  • In recent years, the increase in hours worked has outpaced the growth in the capital
    stock; less capital per worker has been a key driver of the weakness in productivity.
    For example, high demand for wholesale trade services has contributed to a strong rise
    in hours worked, but the capital stock in that industry has yet to catch up. This is
    broadly expected to rebalance over the next few years, contributing to a pick-up in
    productivity.

Inflation continues to moderate and is expected to return to the target range of 2–3 per cent in 2025 and reach the midpoint in 2026.

Inflation is expected to be within the target range in 2025 (Graph 3.7;
Graph 3.8). The decline in inflation is based on the expectations that in the next
couple of years the labour market will be around levels consistent with full employment and
that subdued economic growth will balance demand and supply of goods and services. Inflation
expectations are assumed to remain consistent with achieving the inflation target in this
timeframe.

Graph 3.7



Graph 3.7: A line graph showing the year-ended headline inflation forecast within the RBA’s 70 and 90 per cent historical forecast error bands. It shows headline inflation continuing to decline from its peak in the December quarter of 2022, reaching around 3 per cent by mid-2025. The 90 per cent confidence interval around the forecast of headline inflation in June 2026 spans from around ¼ per cent to around 5 per cent.

Graph 3.8



Graph 3.8: A line graph showing the year-ended trimmed mean inflation forecast within the RBA’s 70 and 90 per cent historical forecast error bands. It shows inflation continuing to decline from its peak in the December quarter of 2022, reaching around 3 per cent by mid-2025. The 90 per cent confidence interval around the forecast of trimmed mean inflation in June 2026 spans from around 1¼ per cent to around 4 per cent.

Inflation is expected to decline a little quicker than previously thought.
Goods price inflation has declined more quickly than expected three months ago, as the
earlier easing in global upstream costs was passed through to consumer-facing prices;
domestic demand is also a little softer than previously anticipated. The recent decline in
fuel prices will lower headline inflation in the March quarter this year; together with the
scheduled expiry of government electricity rebates in 2024, this creates some volatility in
the progress of headline inflation to target.

But, services inflation remains high and is expected to decline only gradually as
domestic inflationary pressures moderate.
A further decline in services inflation
is required for the inflation target to be achieved over time. Recent high inflation
outcomes reflect the still-strong level of demand for services as well as strong growth in
domestic costs. These costs include labour (partly because of poor productivity outcomes)
and non-labour business inputs such as insurance and administrative services. There was a
moderation in services inflation in the December quarter and a further easing is expected
over the forecast period as cost growth eases, and as the demand for services moderates.
Services inflation is expected to be slower to decline than goods inflation, consistent with
the experience of other countries.

Goods price inflation is expected to be subdued over coming years. Recent
inflation outcomes for many categories of goods have now returned to around pre-pandemic
averages. Firms in the RBA’s liaison program have reported a sustained improvement in
supply chains and an easing in imported goods inflation. Domestic cost pressures remain a
source of upward pressure in firms’ pricing decisions, though these cost pressures are
expected to ease over time.

Rent inflation is expected to remain high over the year ahead, before easing
gradually. Growth in advertised rents remains strong. Housing supply has not kept pace with
the increased demand for housing arising from robust nominal income growth and strong
population growth in recent years, as well as the decrease in average household size since
the beginning of the pandemic. This imbalance between supply and demand is contributing to
very low vacancy rates and high rent inflation.

3.3 Key risks to the domestic outlook

The risks to the domestic outlook are assessed to be broadly balanced, though the costs
associated with these risks differ. While some of the downside risks to the outlook would
see a faster return to the inflation target, this would likely be accompanied by a cost to
our employment objective. On the other hand, it would be costly (in terms of both our
employment and inflation objectives) if a sustained period of high inflation led to
inflation expectations drifting upwards.

Key risk #1 – If demand is weaker than expected, it could
lead to spare capacity in the labour market and a faster decline in inflation.

With the labour market expected to be around the level consistent with full employment during
the forecast period, materially weaker demand conditions would lead to spare capacity in the
labour market. At the same time, weaker demand would also temper inflationary pressures,
resulting in inflation returning to target earlier.

Some key channels through which demand could be weaker than expected include:

  • The recent weakness in household consumption could persist for longer than
    expected.
    This could occur if the decline in real disposable incomes over the
    past couple of years has a larger or more persistent effect on consumption than
    anticipated. While many households with mortgages are well placed to absorb the
    increases in interest rates that have taken place, there is a risk that these
    households, especially those with low savings buffers and high debt relative to incomes,
    will adjust spending by more than expected. The increase in interest rates to date could
    also encourage all households to save more than expected, resulting in lower consumption
    growth; this has been evident across a number of peer economies.
  • International demand for Australian goods and services could be weaker than
    expected.
    The outlook for global economic growth remains uncertain, with
    risks tilted to the downside. If services price inflation remains high despite
    further easing in demand growth, interest rates could be higher for longer than
    expected, and global economic growth could, in turn, slow by more than anticipated.

    The expected slowing in China’s growth also continues to create uncertainty
    around the outlook for demand for commodities and, accordingly, the prices of
    Australia’s key exports and terms of trade. Real estate investment has been a
    persistent drag on overall investment since 2021 and this is expected to continue
    for another year or so. The outlook for household consumption in China also remains
    weak, which could pose additional downside risks to Australia’s education and
    tourism exports. While recent policy stimulus announcements have signalled further
    commitment by the Chinese authorities to support economic growth, constraints on
    local government finances could limit their ability to continue to do so. A
    prolonged cyclical downturn in China could further weigh on Australia’s exports
    through its effect on output growth in Australia’s major trading partners in
    the east Asian region, compounding the effects of slower growth in advanced
    economies.

Goods prices could decline significantly if domestic demand or international demand
eases by more than anticipated.
The inflation forecasts broadly assume that goods
prices stabilise at a high level rather than decline over coming years. However, price
declines have been recorded for some categories of goods in recent months. Larger or
widespread declines in goods prices would moderate inflation outcomes by more than currently
forecast. To provide a sense of the magnitude of this risk, if prices for consumer durables
reversed one-third of the price increases recorded since the onset of the pandemic,
year-ended headline inflation would be around ½ percentage point lower than the
current forecast. This would mean that headline inflation would be in the target range in
2024.

Key risk #2 – If inflation takes longer to return to target than anticipated, it could
cause inflation expectations to drift upwards, which would impose costs for our employment
objective.

Inflation is expected to be above the target range for around four years in total according
to staff forecasts. If inflation expectations remain anchored – as assumed in the
baseline forecasts – then inflation is expected to decline alongside an easing in the
labour market. But, there is a risk that inflation will be above the target range for longer
than this, which could result in inflation expectations drifting higher. A drift higher in
inflation expectations would lock in a rate of inflation and nominal wages growth that is
persistently higher, with no benefit to real wages. History suggests that it would require a
sustained and costly period of spare capacity where labour is less than fully employed to
reset expectations.

Some key channels through which inflation could be higher for longer than forecast include:

  • Supply shocks could boost inflation. While the pandemic-related
    disruptions to supply chains have largely resolved, the risk of other supply shocks have
    increased. If there were an escalation of the recent disruptions to global shipping
    routes, goods price inflation could be higher than forecast for a time, which could
    further delay the return of inflation to target.
  • Inflation could be more persistent than expected if productivity growth does not
    pick up.
    The baseline forecasts include an assumption that labour productivity
    growth increases to the rate recorded in the decades preceding the pandemic.
    Productivity growth could prove weaker than forecast if capital deepening does not
    eventuate (i.e. the rate of investment is insufficient relative to employment growth) or
    if the structural factors that were key drivers of the productivity growth slowdown
    since the mid-2000s persist (e.g. declining business dynamism and slowing technology
    adoption). If productivity is weaker than assumed, businesses could find themselves
    facing continued strong growth in labour costs, putting upward pressure on prices paid
    by consumers.
  • Demand could be stronger than expected and inflation could be higher for longer
    than anticipated as a result.
    Household consumption could turn out to be
    stronger than forecast if households are more willing to maintain a low saving rate or
    draw down on their savings in order to support their spending. There is also a large
    amount of work in the construction pipeline that could be worked through more quickly
    than anticipated, increasing the competition for scarce labour and materials. These
    scenarios would result in inflation declining by less than anticipated and employment
    growth being stronger than forecast in the near term. In particular, there is a risk
    that services inflation could remain stubbornly higher than forecast; the evidence from
    other countries suggests that services inflation has moderated only gradually, despite
    progress on other aspects of inflation.

3.4 Detailed
forecast information

The forecasts incorporate several technical assumptions:

  • The cash rate is assumed to move broadly in line with expectations derived from surveys
    of professional economists and financial market pricing. Using this methodology, the
    cash rate remains around its current level of 4.35 per cent until mid-2024
    before declining to around 3¼ per cent by the middle of 2026. This cash
    rate path is a little lower than at the November Statement.
  • The exchange rate is assumed to be unchanged at its current level, which is 1.7 per cent
    higher than the November forecasts on a trade-weighted basis.
  • Crude oil prices are assumed to be broadly unchanged around their current levels for the
    rest of the forecast period, which is around 4 per cent lower than at the
    November Statement.
  • The assumed level of the population has been revised slightly higher. Recent net
    overseas migration has been stronger than expected while migration policy changes are
    expected to provide some offset over the forecast period; year-ended population growth
    is assumed to have peaked in the September quarter at around 2½ per cent,
    after which it is expected to decline back to its pre-pandemic average of around 1½ per cent.

Table 3.1 provides additional detail on forecasts
of key macroeconomic variables (see Box B:
Greater Transparency about Our Forecasts and Assumptions
). The forecast table from
current and previous Statements can be viewed, and data from these tables
downloaded, via the Statement on Monetary
Policy – Forecast Archive
.

Download
a PDF version of this table



Source link

Related Articles

Leave a Reply

Your email address will not be published. Required fields are marked *

Back to top button
SUBSCRIBE TO OUR NEWSLETTER

Get our latest downloads and information first. Complete the form below to subscribe to our weekly newsletter.


    Input this code: captcha