The Reserve Bank has raised the cash rate thirteen times since May 2021 to bring inflation to the target of 2 to 3 percent. Encouragingly, inflation growth has been moderating. Inflation has come down a long way, from almost 8 per cent in late 2022 to 3.8% in the June quarter of this year. Despite this progress, there are concerns about persistent or sticky inflation in essential services, such as housing rents, insurance and education.
Recent remarks from Reserve Bank Governor Michele Bullock provide some insight into the timing of potential rate relief. In early August, the Reserve Bank Board decided to keep the cash rate unchanged at 4.35%, where it has been since November 2023. Bullock flagged in her press conference that followed that rate cuts are unlikely in the near term. In fact, her remarks suggest that Australians might not see a reduction in rates until 2025 at the earliest.
Interest-rate markets at the end of August are expecting rate cuts to start in February 2025 followed by three more over next year, taking the cash rate to 3.35%.
The Reserve Bank will be watching many factors closely, but arguably will pay more heed to the jobs market and consumer spending.
Trends in the labour market are important. Policymakers have continued to stress the important of keeping the economy on a “narrow path”, which means curbing inflation whilst sustaining a low rate of unemployment. A tricky task to navigate.
So how is the economy faring on this front? The unemployment rate has risen from a 50-year low of 3.5% in late 2022 to a 2½-year high of 4.2% in June. The rise in the unemployment rate has been more notable in the past six months and has occurred despite a string of strong jobs growth. Indeed, in the last six months, the average jobs gain per month has been around 51,000 – a very solid outcome. So, what’s up with strong jobs growth and rising unemployment?
The explanation lies with the explosive growth of people in the Aussie economy. The net increase in overseas migration was a record 547,000 in 2023. This increase is adding to the size of the labour force and has helped alleviate some of the labour shortages businesses were experiencing through last year and late 2022. More people have been finding work but there also more job seekers, spurring the participation rate to a record high.
Looking ahead, indicators such as job advertisements and application rates suggest a potential slowdown in job growth over the year ahead. Economic activity is also toddling along at a sub par pace, which may make it harder for the unemployment rate to stop rising.
At the same time, the growth in the population has helped provide some resilience to consumer spending in total terms. But in per capita terms, which strips out the impact of people, consumer spending has been dismal, contracting for almost two years. Consumer sentiment remains downbeat and may not improve noticeably until rate cuts materialise.
On the other hand, businesses are less downbeat and, in fact, remain even cautiously optimistic. A point of difference is that households have run down their savings whilst businesses are yet to deplete the financial reserves accumulated during the pandemic.
As we wait for rate relief, improving productivity is crucial for enhancing economic resilience and managing inflation effectively. Productivity growth boosts economic output and can help mitigate cost-of-living pressures by allowing more efficient use of resources. However, Australia has faced productivity challenges.
There is no one answer or one size fits all to boosting productivity. There are several factors that may help boost productivity, including improving competition, prioritising investment in research and development, embracing new technologies and boosting business dynamism. Enhancing workforce skills through improved education and training will also help workers adapt to evolving job requirements in a world that is rapidly changing.
The rapid changes, including by the growth in artificial intelligence, and structural changes such as the ageing of the population, declining fertility rates, the intensification of the fragmentation of globalisation and geopolitics adds to uncertainty. It also means inflation risks may be higher than the decade before covid. If this is true, the Reserve Bank may not need to cut the cash rate as deeply as in recent cycles.
Deciphering how soon rate relief arrives also means assessing fiscal policy settings and the impact of Stage 3 tax cuts. A Federal election by May next year falls into the mix and a Federal Budget will be handed down before the next election.
Another rate hike is off the table and rate relief may come as soon as February 2025, but it is far from a done deal.
Hear more from Besa at the BCCM Leaders' Summit
Hear more from Besa Deda at this year's 2024 BCCM Leaders' Summit in Business Leaders in Conversation, an entertaining and informative conversation between Andrew Hadley CEO P&N Bank, Michael Chaney AO Chair Wesfarmers and Besa Deda Chief Economist, ABE Chair and Market Strategist, chaired by ABC Business Correspondent Peter Ryan. Limited tickets available.
