Outlook | Statement on Monetary Policy – February 2024 (2024)

3.1Global outlook

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

Year-average GDP growth in Australia’s major trading partners is expected toease in 2024, contributing to weaker growth in demand for Australian goods andservices. This overall outlook is little changed from three months ago, withstronger forecast growth in the United States and high-income economies in east Asia offsetby weaker growth in some other advanced economies (Graph3.1).

Central banks are generally forecasting that inflation in advanced economies willdecline to be consistent with central bank targets over the next year or so, though flagupside risks. This expectation of a decline in inflation is alongside expectationsof softer economic growth and a moderate easing in labour markets. Reflecting this, marketexpectations are that policy rates have peaked (see Chapter1:Financial Conditions). In particular, GDP growth in advanced economies is forecastto slow substantially this year, partly reflecting the effects of tighter monetary policy ondemand. In most G7economies, private sector economists’ forecasts of growth for2024 are well below the average growth of the decade prior to the pandemic, although USgrowth is expected to slow only moderately. Overall G7economic growth is forecast topick up moderately from the latter half of 2024 and is expected to be supported by lessrestrictive monetary policy settings in a number of economies.

Growth in China is expected to slow over the next two years as the reboundin services consumption fades and the property sector remains weak. Weakness in thesesectors is expected to be partly offset by continued strength in manufacturing investmentand 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 demandslows further, leading to more restrictive monetary policy and softer global economicgrowth than anticipated. Recent progress towards inflation targets has beenfaster than expected in some economies, but services inflation – which remains akey focus of many central banks – has eased only gradually and may remainstubbornly high. Recent disruptions to global shipping routes pose an additional modestupside risk to global inflation and downside risk to growth; this risk could become morematerial 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 inmonetary policy will weigh on economic activity. Recent further progresstowards central bank inflation targets has reduced the likelihood that additionalmonetary policy tightening will be required in major advanced economies. However, lagsin monetary policy transmission mean uncertainties remain (in both directions) about thefull 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 tocontinued weakness in the property sector and weaker-than-anticipated householdconsumption. Demand for housing in China remains weak despite further policymeasures to support the sector. A deeper and more prolonged contraction in the propertysector could weigh more heavily on household consumption, particularly if consumerconfidence remains subdued and further policy support is limited. If weakness in Chinesedemand were to compound the effects of soft demand from advanced economies, this couldweigh on exports (and so economic growth) of other trade-exposed economies in east Asia.

3.2The domestic outlook

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

The near-term outlook for GDP growth has been revised down modestly from three monthsago, reflecting a weaker outlook for consumer spending. The soft outlook for GDPgrowth in the near term reflects subdued domestic final demand growth (Graph3.2). Thepressure on household budgets from declines in real incomes over the past couple of years isexpected to weigh on consumption, particularly in the first half of 2024. High constructioncosts 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 fromthe high rates seen over the past year. However, the level of investment is expected toremain high, as firms continue to work through the large pipeline of construction work.Strong population growth – driven by growth in international students – and thecontinued recovery in inbound tourism is expected to support domestic activity in the nearterm and provide some offset to weak spending by Australian residents.

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

The forecasts are based on the technical assumption that the cash rate is around its peak inthe current cycle and will remain around this level until the middle of 2024; the cash ratepath is based on financial market pricing and a survey of market economists (see Table3.1: Detailed Forecast Table for more information).While high inflation affects all households and businesses, monetary policy tighteningaffects the cash flows of groups of households in different ways. Our assessment is thatmost of the two-fifths of households that have a mortgage are well placed to manage mortgagerates around their current levels, by continuing to curtail spending, saving less or drawingdown on savings buffers.^[1]But, around 5percent of borrowers are currently estimated to have insufficientincome to meet their most essential expenses and mortgage payments, and so are drawing downon savings or finding other ways to increase their income or reduce expenditure. Some ofthese borrowers are at risk of depleting their buffers within six months, which would seethem fall behind on mortgage payments. Conversely, households that are net savers arebenefiting from higher interest earned. The other channels of monetary policy are alsoworking to slow the growth of demand and contributing to the decline in inflation, such asby 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 reflectingstronger growth in household consumption and public demand. Household consumptiongrowth 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 (Graph3.3).The household saving ratio is expected to decline further in the near term before increasinggradually from mid-2024 as real income growth turns positive. Dwelling investment isforecast to increase from 2025 onwards as earlier strong population growth and higher pricesfor established housing lead to a pick-up in demand for new housing. The forecasts for GDPgrowth beyond the near term are broadly similar to three months ago.

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

Employment is expected to increase further, but at a slower pace than lastyear. Much of the labour market adjustment to subdued growth in economic activityis expected to occur through a decline in average hours worked. But employment growth isalso forecast to slow and to be below growth in the working-age population for a time. Therate of participation in the labour force is expected to decline a little over the forecastperiod as conditions soften, but it is expected to remain at a high level. (Changes in theassumption for growth in the working-age population have been small relative to the largeupward revisions that occurred last year because of stronger-than-expected net overseasmigration.)

Labour underutilisation rates are expected to rise as employment growth moderates andaverage hours worked decline. Both the broader hours-based underutilisation rate(i.e. people working fewer hours than they want) and the unemployment rate have increasedsince late 2022 when labour market conditions were very tight, and a further increase isexpected over coming quarters in response to slower economic growth (Graph3.4). Thatsaid, the underutilisation rates forecast over the next few years are well below the typicalrates of the past five decades.

The labour market forecasts are broadly consistent with a return to full employmentconditions that can be sustained over time without adding to inflationarypressures. It appears that the economy will be able to sustain lower levels oflabour underutilisation than were typically seen over the past five decades. The assessmentof the labour market relative to full employment is based on a broad range of indicators,models and judgement (see Chapter4: InDepth – Full Employment for more detail).

…leading to a gradual easing in nominal wages growth.

Nominal wages growth is expected to remain robust in the near term, and then declinegradually in line with the easing in the labour market. Wages growth has alreadybegun to moderate in some parts of the private sector and the moderation is expected todeepen and broaden out over the coming year (Graph3.5).

The recent increase in real wages is expected to continue over the next couple ofyears; nominal wages are expected to increase at a faster pace than inflation(Graph3.6).

Growth in broad measures of labour costs is high becauserecent labour productivity outcomes have been weak. Recent growth in nominal unitlabour costs – the measure of labour costs that matters most for inflation – hasbeen at the highest rate since 1990 (excluding pandemic-impacted outcomes in 2020). Growthin 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; thisassumption is embedded in the forecasts. While productivity growth is difficult to forecastand there are risks that productivity will be weaker than anticipated (see 3.3Keyrisks to the domestic outlook), much of the recent weakness in productivity has beena by-product of the pandemic and the economic cycle and will likely unwind over the next fewyears. For example:

• The strong labour market has drawn in new workers and allowed others to change jobs moreeasily. This boost to employment is a good social and economic outcome, but it requiresa transition period as people are trained in a new role. In time, job mobility can boostproductivity through the benefits of better matching of people’s skills with jobs.
• Some industries that faced capacity challenges in recent years, partly related to thepandemic and weather disruptions, could see an improvement in productivity as thesechallenges dissipate. For example, activity in the construction industry has beenhampered by shortages that have led to delays in the way work is completed. But theimprovement in the availability of materials and skilled labour is gradually reducingdelays. In some industries – such as tourism– capacity has been insufficientto meet demand given the lags for firms (such as tourism operators) to re-establishinfrastructure and resources, after a period of low demand.
• In recent years, the increase in hours worked has outpaced the growth in the capitalstock; 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 risein hours worked, but the capital stock in that industry has yet to catch up. This isbroadly expected to rebalance over the next few years, contributing to a pick-up inproductivity.

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 (Graph3.7;Graph3.8). The decline in inflation is based on the expectations that in the nextcouple of years the labour market will be around levels consistent with full employment andthat subdued economic growth will balance demand and supply of goods and services. Inflationexpectations are assumed to remain consistent with achieving the inflation target in thistimeframe.

Inflation is expected to decline a little quicker than previously thought.Goods price inflation has declined more quickly than expected three months ago, as theearlier 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 infuel prices will lower headline inflation in the March quarter this year; together with thescheduled expiry of government electricity rebates in 2024, this creates some volatility inthe progress of headline inflation to target.

But, services inflation remains high and is expected to decline only gradually asdomestic inflationary pressures moderate. A further decline in services inflationis required for the inflation target to be achieved over time. Recent high inflationoutcomes reflect the still-strong level of demand for services as well as strong growth indomestic costs. These costs include labour (partly because of poor productivity outcomes)and non-labour business inputs such as insurance and administrative services. There was amoderation in services inflation in the December quarter and a further easing is expectedover 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 withthe experience of other countries.

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

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

3.3Key risks to the domestic outlook

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

Key risk #1 – If demand is weaker than expected, it couldlead 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 duringthe forecast period, materially weaker demand conditions would lead to spare capacity in thelabour 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 thanexpected. This could occur if the decline in real disposable incomes over thepast couple of years has a larger or more persistent effect on consumption thananticipated. While many households with mortgages are well placed to absorb theincreases in interest rates that have taken place, there is a risk that thesehouseholds, 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 couldalso encourage all households to save more than expected, resulting in lower consumptiongrowth; this has been evident across a number of peer economies.

• International demand for Australian goods and services could be weaker thanexpected. The outlook for global economic growth remains uncertain, withrisks tilted to the downside. If services price inflation remains high despitefurther easing in demand growth, interest rates could be higher for longer thanexpected, and global economic growth could, in turn, slow by more than anticipated.

  The expected slowing in China’s growth also continues to create uncertaintyaround the outlook for demand for commodities and, accordingly, the prices ofAustralia’s key exports and terms of trade. Real estate investment has been apersistent drag on overall investment since 2021 and this is expected to continuefor another year or so. The outlook for household consumption in China also remainsweak, which could pose additional downside risks to Australia’s education andtourism exports. While recent policy stimulus announcements have signalled furthercommitment by the Chinese authorities to support economic growth, constraints onlocal government finances could limit their ability to continue to do so. Aprolonged cyclical downturn in China could further weigh on Australia’s exportsthrough its effect on output growth in Australia’s major trading partners inthe east Asian region, compounding the effects of slower growth in advancedeconomies.

Goods prices could decline significantly if domestic demand or international demandeases by more than anticipated. The inflation forecasts broadly assume that goodsprices stabilise at a high level rather than decline over coming years. However, pricedeclines have been recorded for some categories of goods in recent months. Larger orwidespread declines in goods prices would moderate inflation outcomes by more than currentlyforecast. To provide a sense of the magnitude of this risk, if prices for consumer durablesreversed one-third of the price increases recorded since the onset of the pandemic,year-ended headline inflation would be around ½percentage point lower than thecurrent forecast. This would mean that headline inflation would be in the target range in2024.

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

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

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

• Supply shocks could boost inflation. While the pandemic-relateddisruptions to supply chains have largely resolved, the risk of other supply shocks haveincreased. If there were an escalation of the recent disruptions to global shippingroutes, goods price inflation could be higher than forecast for a time, which couldfurther delay the return of inflation to target.
• Inflation could be more persistent than expected if productivity growth does notpick up. The baseline forecasts include an assumption that labour productivitygrowth increases to the rate recorded in the decades preceding the pandemic.Productivity growth could prove weaker than forecast if capital deepening does noteventuate (i.e. the rate of investment is insufficient relative to employment growth) orif the structural factors that were key drivers of the productivity growth slowdownsince the mid-2000s persist (e.g. declining business dynamism and slowing technologyadoption). If productivity is weaker than assumed, businesses could find themselvesfacing continued strong growth in labour costs, putting upward pressure on prices paidby consumers.
• Demand could be stronger than expected and inflation could be higher for longerthan anticipated as a result. Household consumption could turn out to bestronger than forecast if households are more willing to maintain a low saving rate ordraw down on their savings in order to support their spending. There is also a largeamount of work in the construction pipeline that could be worked through more quicklythan anticipated, increasing the competition for scarce labour and materials. Thesescenarios would result in inflation declining by less than anticipated and employmentgrowth being stronger than forecast in the near term. In particular, there is a riskthat services inflation could remain stubbornly higher than forecast; the evidence fromother countries suggests that services inflation has moderated only gradually, despiteprogress on other aspects of inflation.

3.4Detailedforecast information

The forecasts incorporate several technical assumptions:

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

Table3.1provides additional detail on forecastsof key macroeconomic variables (see BoxB:Greater Transparency about Our Forecasts and Assumptions). The forecast table fromcurrent and previous Statements can be viewed, and data from these tablesdownloaded, via the Statement on MonetaryPolicy – Forecast Archive.

Downloada PDF version of this table