Economic Outlook | Statement on Monetary Policy – May 2023 (2024)

Global growth is forecast to remain well below its historical average over the next two years, as highinflation and tighter monetary policy settings are expected to continue to weigh on demand. The forecastfor growth in Australia’s major trading partners has been revised up a little, largely because of anupward revision to the outlook for Chinese GDP growth. The previously very weak outlook for economicgrowth in major advanced economies has also been upgraded in response to stronger-than-expected economicactivity data in early 2023; however, the outlook in these economies remains subdued (see Chapter1: The International Environment).

Growth in Australian economic activity is expected to have slowed in the March quarter and is forecast toremain subdued through this year as higher interest rates, the higher cost of living and earlier declinesin household wealth continue to weigh on growth. The pace of growth is expected to increase graduallyover the remainder of the forecast period as these headwinds fade. There has been a further upgrade tothe population estimate, which mainly affects population growth in recent quarters rather than over theforecast period.

The labour market remains tight and employment growth remained solid through the March quarter. That said,the balance between labour demand and supply has improved; the recent pick-up in overseas migration maybe helping to alleviate shortages in some areas. The unemployment rate is forecast to rise over comingyears because of subdued economic growth.

Consumer price inflation in Australia eased in the March quarter, confirming that inflation has passed itspeak. Goods prices have accounted for most of the disinflation so far and this is forecast to continueover 2023 as the resolution of supply disruptions flows through to prices paid by consumers. By contrast,services and energy inflation remains strong and this is expected to continue in the near term. Theoutlook for inflation over coming years is similar to three months ago, although its composition hasshifted. Non-housing inflation is expected to be slower because of downgrades to the outlook foractivity, the labour market and labour costs. This is offset, however, by a stronger outlook for rentinflation, reflecting the strength in recent data and the upward revisions to the population growthestimate.

Inflation is expected to decline to around the top of the 2–3percent target range over coming years. Inflation couldturn out to be more persistent if productivity growth remains weak, the high inflation environment leadsto firms expanding margins as their costs ease, there is greater feedback between higher prices and wagesthan expected, or if rents increase by more than expected. On the other hand, inflation could turn out tobe lower than expected if the easing in goods inflation is faster or more widespread than anticipated,including because consumer spending is weaker.

A key source of uncertainty for the domestic activity outlook is the competing forces affecting householdspending. Household incomes have been supported by strong labour demand and higher population growth. Butconsumption growth has slowed recently as high inflation and rising interest rates have weighed onhouseholds’ disposable incomes in real terms and household wealth has fallen alongside housingprices over the past year. Another important source of uncertainty for the Australian economy is theoutlook for global growth. Most notably, there is uncertainty around the pace of disinflation and so thefuture path of monetary policy and economic growth abroad. While financial stability concerns related tobanking sector stresses have subsided, they would pose downside risks to the global economic outlook ifthe situation were to deteriorate again and financial conditions were to tighten substantially.

The forecasts are based on some technical assumptions. The path for the cash rate reflects expectationsderived from surveys of professional economists and financial market pricing prior to the May Boardmeeting. The cash rate is assumed to peak at around 3¾percent before declining to around3percent by mid-2025, broadly in line with the assumed path in February. The exchange rate isassumed to be unchanged at its level prior to the May Board meeting, which is 4percent belowits level three months ago on a trade-weighted basis. Petrol prices are assumed to be broadly unchangedaround their recent level, which is around 10c/L higher than in early February. The level of thepopulation has been revised higher and population growth projections are broadly in line with the latestAustralian Government’s Centre for Population forecasts. Higher migration reflects the recentfaster-than-expected recovery of temporary migrants, especially students and working holiday makers, witha strong recovery in arrivals alongside low levels of departures.

Inflation in Australia has peaked

Consumer price inflation in Australia eased in the March quarter, confirming that inflation has passed itspeak (Graph5.1). Goods price disinflation has driven most of the moderation in inflation outcomesin early 2023, consistent with but a little later than the experience overseas. Nonetheless, inflationremains high and broadly based and services inflation continues to pick up. The outlook for headline andunderlying inflation has been revised lower in the near term due to the slightly weaker-than-expectedMarch quarter outcome. Further out, the outlook is similar to a few months ago, with the effect of thedowngrades to the labour market and labour costs offset by a stronger outlook for rent inflation and asmall depreciation in the exchange rate.

Energy prices are expected to add significantly to inflationary pressures over the coming year. Regulatorsreleased draft determinations of the default offers for electricity prices in the 2023/24financial year and these were largely in line with priorexpectations. Energy prices in the CPI (which includes both electricity and gas) are expected to add¼percentage point to headline inflation over the 2023/24financial year. Energy price changes are expected to berelatively small in the 2024/25financial year, based on currentwholesale prices in futures markets.

Goods price inflation is forecast to moderate further in the period ahead, consistent with the experienceoverseas. Information from liaison and other timely indicators signal that pricing pressures have easedsince mid-2022. This is largely driven by an easing in non-labour input cost pressures, which has beenmost notable for international freight and some imported goods. However, domestic cost pressures such asenergy, wages and logistics remain a source of upward pressure in firms’ pricing decisions. Comparedwith a few months earlier, retailers have increasingly cited weaker demand as a constraint on theirability to increase prices.

Services inflation is forecast to remain high in 2023, before moderating slowly over the forecast period;as a result, inflation is expected to be above the target band over most of the forecast period. Growthin unit labour costs is expected to be solid over the forecast period, adding to cost pressures forlabour-intensive market services. Rental vacancy rates are low and stronger population growth willcontribute to further tightness in the rental market in the period ahead. As a result, rental priceinflation is expected to increase further over coming quarters as higher rents work their way through thestock of outstanding rental agreements.

Underlying inflation is expected to decline over coming years to be around the top of the inflation targetrange by mid-2025 (Graph5.2). The disinflation in 2023 is expected to be driven by the resolutionof supply disruptions (Graph5.3). Ongoing tightness in the labour market and further energy priceincreases are expected to keep domestic price pressures elevated in the near term before they start toease later in the forecast period. There is a high degree of uncertainty around the speed and extent ofthe disinflation expected in the period ahead. On the one hand, lower goods prices from the resolution ofsupply chain issues could come through sooner and swifter than anticipated. On the other hand, domesticprice pressures may be stronger and more persistent than expected. These risks are discussed further inthe section on ‘Key domestic uncertainties’, below.

Economic growth is expected to slow this year

GDP growth is expected to slow to around 1¼percent over 2023, with GDP per capita decliningover the year (Graph5.4). The weaker near-term outlook relative to three months ago reflects thesoftness in recent activity data. Domestic demand growth stalled in the December quarter, and timelyindicators suggest subdued growth in early 2023. Household consumption growth is expected to remainsluggish through this year as inflation and higher interest rates weigh on real disposable income.Consumption growth is expected to increase to around its pre-pandemic trend over 2024 as the effect ofthe earlier monetary policy tightening wanes and the cash rate decreases, inflation moderates, householdwealth recovers and tax cuts support disposable income.

The recovery in consumption, alongside faster growth in public demand, supports a forecast pick-up in GDPgrowth in 2024. The outlook for non-mining business investment over the forecast period remains positivebut has softened in response to weaker demand conditions. Export volumes are expected to grow strongly,driven by the ongoing rebound in tourism and education-related travel. Broadly corresponding growth inimports, including travel services, means trade is expected to have little net effect overall on GDPgrowth over most of the forecast period.

Consumption growth is expected to slow because of rising prices and higher interest rates

Household consumption growth is expected to remain subdued in 2023, and slowly increase over the rest ofthe forecast period (Graph5.5). While strong labour market outcomes continue to support householdincome growth this year, consumption growth is expected to be dampened by higher consumer prices, netinterest expenses, tax payable and the decline in housing prices seen over 2022. From the second half of2023, consumption growth is expected to gradually increase towards its average rate prior to thepandemic, as a range of factors support both wealth and household disposable income growth. The recentstabilisation in housing prices supports household wealth relative to expectations in February.Additionally, a pick-up in real household disposable income growth is supported by lower inflation, aswell as the legislated ‘Stage 3’ tax cuts from mid-2024.

The household saving ratio is expected to continue to decline over the next year or so, before increasinggradually from mid-2024.

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Cost Of Capital

The outlook for private investment has softened

A large pipeline of residential and non-residential construction projects is expected to support activityover 2023. While the recent flow of data and information from the Bank’s liaison program indicatesthat materials shortages and related supply chain issues have largely been resolved, shortages of skilledtradespeople remain a significant constraint on activity and are limiting the pace at which the pipelineof projects can be worked through. Most construction firms continue to report that they are operating ataround full capacity.

Dwelling investment is expected to decline once the backlog of construction is worked through, consistentwith the very weak demand for new detached dwellings (Graph5.6). High construction costs,construction delays and housing price declines over 2022 have reduced the incentive to build newdwellings. This is consistent with the recent decline in building approvals, greenfield land sales andnew home sales. Information from liaison with developers suggests that investor demand for higher densitydwellings has been very weak in recent months. Although an increase in rental yields since the start of2022 and strong inward migration may support investor demand in future, higher density housing supply isexpected to respond with a significant lag due to long planning and construction lead times. Aftergaining planning approvals and pre-sales, the average apartment building takes more than two years tobuild.

Non-mining machinery and equipment investment is expected to remain at a high level over the forecastperiod. Information from the ABS Capital Expenditure survey suggests that firms’ nominal investmentintentions for the current financial year remain robust, though this partly reflects the higher cost ofundertaking a given volume of investment. Intentions for the 2023/24financial year are significantly weaker, and forward-lookingmeasures of business conditions and confidence have softened. The resolution of supply chain pressures isexpected to support investment in machinery and equipment in the near term.

Mining investment is expected to be broadly unchanged over coming years. While expansionary iron ore andLNG projects are expected to drive some growth over 2023, the vast majority of mining investment remainssustaining in nature and is intended to replace ageing infrastructure.

Public demand is forecast to remain at a high level

Public demand as a share of nominal GDP is expected to remain at a high level over the forecast period. Adecline in pandemic-related spending is expected to weigh on public consumption throughout most of 2023.Further out, public consumption is expected to resume expanding, partly due to public spending programssuch as the National Disability Insurance Scheme.

Public investment is expected to grow over the forecast period. The pipeline of public engineering work isanticipated to support a high level of public capital expenditures for several years. The speed of therollout will continue to be affected by capacity constraints in the construction sector, particularly inthe near term.

Education and travel exports will continue to recover

Export volumes are expected to continue to grow strongly over 2023, driven by services exports, as travelcontinues to recover to pre-pandemic levels. The expected number of international students studying inAustralia over the next couple of years has been upgraded significantly. Resource exports are expected togrow gradually from the second half of 2023, supported by drier weather. Rural export volumes areexpected to decline throughout the forecast period as growing conditions normalise following theconclusion of the third consecutive La Niña event.

The terms of trade are expected to increase in the March quarter, mostly driven by lower import prices,and to remain elevated but decline over the remainder of the forecast period as commodity prices decline,partly offset by a gradual easing in import prices (Graph5.7).

The unemployment rate is expected to increase as economic growth slows

Labour market spare capacity remains around multi-decade lows. Labour underutilisation (as measured by theunemployment rate and by people working fewer hours than they want) is expected to gradually increase asa result of subdued economic growth over coming years; the unemployment rate is nonetheless expected toremain below pre-pandemic levels (Graph5.8). Employment growth is expected to moderate, withaverage hours worked also expected to resume its longer term downward trend from late 2023(Graph5.9).

The balance between labour demand and supply has improved recently. The pick-up in overseas migrationsince the reopening of the international border should further help alleviate labour shortages in someindustries over time in the face of solid demand for labour, while also adding to aggregate demand in theeconomy. Participation in the labour force is expected to be sustained around historically high levelsover the forecast period. The effect of the cyclical slowing in the labour market is expected to bepartly offset by structural trends, including higher female and older worker participation.

Labour cost growth is expected to be solid

Labour cost growth picked up throughout 2022. The December quarter outcomes for wages and broader measuresof labour income were generally softer than expected, suggesting that the very strong September quarteroutcomes had overstated the underlying momentum in labour cost growth to some extent. Nonetheless,year-ended labour cost growth reached its highest levels in over a decade at the end of 2022. Withproductivity growth very weak over 2022, growth in unit labour costs was around multi-decade highs.

Timely indicators suggest that wages growth was solid in the March quarter of 2023. Firms in theBank’s liaison program report their wages growth has stabilised at around 4percent andexpect growth to moderate in the year ahead. Market economists and unions expect wages growth to bearound 3¾ to 4percent over the year ahead and to then moderate over the following year.Developments in state government wages policies have evolved broadly as expected a few months ago andsupport the view that public sector wages growth will increase over coming years.

Growth in the Wage Price Index (WPI) – a measure of changes in base wage rates for a given quantityand quality of labour – is expected to reach 4percent in the second half of 2023 beforedeclining to 3¾percent in mid-2025 (Graph5.10). The near-term outlook is lower than afew months ago, reflecting the weaker-than-expected December quarter WPI outcome, the signal from timelyindicators of wages growth and the softer labour market outlook. The annual minimum and award wagedecision by the Fair Work Commission and the 15percent wage increase for aged care workerswill support wages growth later in 2023.

WPI growth is expected to ease in the second half of the forecast period as labour market capacityconstraints become less binding. However, the expected easing in wages growth remains relatively modest,reflecting inertia in the wage-setting process, elevated inflation putting upward pressure on nominalwages in the near term and a still relatively tight labour market.

Broader measures of labour cost growth are expected to increase at a faster rate than the WPI over theforecast period as employers use bonus payments to retain or attract staff and as more hours are workedat overtime rates. These broader measures imply less of a decline in real incomes than suggested by theWPI measure (Graph5.11). The forecast for labour costs is consistent with inflation returning tothe Bank’s target, provided productivity growth picks up back to pre-pandemic trends.

Key domestic uncertainties

Global financial instability could weigh on growth

If recent global financial stability concerns were to re-emerge and prompt tighter financial conditionsand slower growth in the global economy, this could pose a downside risk to domestic economic activity.There could be direct effects on Australia’s exports due to a slowdown in the growth ofAustralia’s major trading partners, as well as a decline in the terms of trade if demand forcommodities were to soften. Widespread financial instability elsewhere could also affect business andconsumer sentiment. A loss of confidence in the global banking system or a rise in risk aversion couldcause a tightening in domestic financial conditions, including by causing bank funding costs to increaseand credit to become more expensive or less easily available, which could affect consumption andinvestment. However, the risk of financial contagion to Australia may be limited because, as set out inthe April Financial Stability Review, Australia’s banks are well regulated, wellcapitalised, profitable and highly liquid. As a result, they are well placed to continue supporting thedomestic economy, even if economic conditions were to become materially worse than expected.

The outlook for household consumption is subject to competing forces

The outlook for household consumption remains a key uncertainty for domestic activity. Housing prices havestabilised recently and could increase faster than previously expected over the forecast period. Thiscould lead to a more rapid turnaround in household consumption growth, including via increased housingturnover and increased ability to obtain credit. Further, many households built savings buffers duringthe pandemic; if households are more willing to spend from these liquid savings than from other forms ofwealth, spending could be stronger than anticipated for a time. This would be reflected in a larger fallin the household savings ratio. Stronger-than-expected growth in domestic demand would see domesticinflationary pressures build further.

On the other hand, weakness in household consumption could persist for longer than expected if there is aresumption of housing price declines, or if weak real disposable income growth has a larger effect thanexpected, particularly on low-income households that typically have lower savings buffers. Manyhouseholds are well placed to absorb higher interest rate costs without significant spending cuts.However, interest rates have risen quickly and there is a risk that some households with low savingsbuffers and high debt relative to incomes will have to adjust their spending sharply.

Inflation could be more persistent than expected

Underlying inflation is expected to take a couple of years to return to the inflation target. However, itis possible that the easing in inflation takes longer than this, consistent with the persistence inservices inflation experienced overseas so far. In a high inflation environment, it is easier for firmsto increase prices; people also tend to pay closer attention to changes in costs and prices than wheninflation is low, and so may come to expect further large price increases. While margins outside of themining sector have been broadly stable in recent years, firms may expand their margins as costs ease ifdemand remains sufficiently strong. Alternatively, there could be stronger feedback between wages andprices. In either case, inflation would be persistently higher throughout the forecast period, whichincreases the risk that inflation expectations become de-anchored. Recent outcomes for private sectorlabour cost growth suggest that the risk that prices and wages start to chase each other is lower than afew months ago. However, larger increases to minimum and award wages and the lifting or removal of wagecaps by state governments could have greater spillover effects on the wages of other workers thancurrently expected.

Inflation could also be more persistent if productivity growth does not pick up, which would make thecurrent outlook for labour costs more inflationary than anticipated. The forecasts presented aboverequire productivity growth to increase to the relatively slow rates recorded in the years preceding thepandemic. Productivity growth is currently weaker than this, and that weakness could persist; that said,the effects of the pandemic have made it difficult to discern the underlying trend. Conversely,productivity growth could rise above the typical pre-pandemic rate if innovations implemented by firmsduring the pandemic begin to pay dividends.

Rent inflation could also be higher and more persistent than forecast. The pick-up in population growth isoccurring at a time when the rental market is already very tight, and it will take time for supply torespond. Higher rents are likely to encourage the average number of people living in each dwelling toincrease, which would be a reversal of the decline that occurred during the pandemic as people soughtmore space. It is possible that rents need to rise by more than expected to bring about this increase inhousehold size. On the other hand, a larger increase in household size would moderate demand and priceincreases by more than expected.

Goods prices could decline significantly and weigh on inflation outcomes

The inflation forecasts presented above assume that goods prices stabilise at a high level but do notdecline over coming years. Supply chain conditions are back around pre-pandemic norms and goods inflationhas eased in most advanced economies. Large or widespread declines in goods prices would moderateinflation outcomes by more than currently expected. One way this could occur is if the simultaneoustightening of monetary policy across many economies affects demand by more than the sum ofindividual-economy effects would imply. Alternatively, strong competition for customers in an environmentof weaker domestic demand could cause larger-than-expected price discounting. To give a sense of themagnitude of this risk, if prices for consumer durables reversed one-third of the price increasesrecorded since the onset of the pandemic, year-ended headline inflation would be around ½percentagepoint lower than the current forecast. This would mean that inflation would be around the middle of thetarget range in the second half of 2024, instead of being above it.