Statement on Monetary Policy – August 20242. Economic Conditions

2.1 Global economic conditions

Overall, growth in Australia’s major trading partners appears to have eased a little more than expected in the June quarter, driven by weaker growth in China.

Growth in China slowed significantly in the June quarter (Graph 2.1). Authorities noted that flooding and heatwaves temporarily restrained consumption and investment in the quarter. Strong external demand again contributed to growth, but by much less than in the March quarter. Strong growth in manufacturing investment is being partly offset by ongoing weakness in property investment, which has been the key headwind to growth in the post-pandemic period. Housing starts, sales and prices all indicate that conditions in the property sector remain very weak.

Weaker-than-expected activity outcomes in China have weighed on sentiment in commodity markets. Iron ore and base metals prices have declined recently, despite underlying demand remaining relatively stable and some ongoing concerns from disrupted production and closures of copper and zinc mines across a range of locations (Graph 2.2). At China’s recent ‘Third Plenum’ (where authorities outline their long-term economic and political reform agenda) little was outlined to address the ongoing downturn in the property sector and lift sentiment in commodity markets. As expected, authorities in China did not signal a large change in short-term economic policy direction, though they did recommit to this year’s growth target of ‘around 5 per cent’. A number of key reforms were identified, which could potentially support growth in the short-to-medium term, particularly those focused on fiscal reform and increasing the provision of social services to migrant workers.

Elsewhere, growth has remained robust in the United States and is gradually recovering in most other advanced economies (though remains below trend).

GDP growth over the past year has been weak across most advanced economies, but now seems to be gradually recovering (Graph 2.3). In some economies this recovery has been stronger than expected, though growth is generally still below estimates of potential. By contrast, GDP growth in the United States strengthened and surprised to the upside in the June quarter, although overall the pace is continuing to moderate. Tight monetary policy continues to weigh on growth in advanced economies; while many central banks are cutting (or planning to cut) rates, monetary policy is still assessed as restrictive (see Chapter 1: Financial Conditions).

Consumption in many advanced economies is recovering as real household disposable income has continued to increase. However, data on retail sales suggest the recovery has been a little slower than expected in some economies, including the euro area and Canada. In the United States, consumption growth in the June quarter was stronger than expected, though real household disposable income growth has declined in recent months, suggesting some moderation in consumption growth is likely underway. Business investment intentions have been mixed across advanced economies. In the euro area and Canada intentions are relatively weak but have improved in recent months, while intentions remain relatively unchanged in the United States.

Timely activity indicators generally signal continued recovery in growth into the September quarter. While surveyed business conditions in services sectors remain expansionary, recent data on manufacturing sector conditions are weaker and more mixed (Graph 2.4). Overall business conditions have moved into expansionary territory in the United Kingdom but have moved further into contractionary territory in the euro area. Conditions in New Zealand have deteriorated quite sharply into contractionary territory in recent months.

Shipping costs have increased significantly since May, which poses an upside risk to global goods inflation if sustained.

Recovering consumption and an associated inventories restocking cycle have contributed to strong demand for goods from China and east Asia. This is putting additional pressure on global shipping capacity, already strained due to the conflict in the Middle East and the associated increase in shipping travel times. Market participants also report some bringing forward of shipments ahead of actual and anticipated tariffs, though the effect of this is difficult to quantify. As a result, container rates have increased sharply since May (Graph 2.5). While this has not yet materialised in higher global goods inflation, it could pose an upside risk if sustained, with possible spillovers to goods inflation in Australia.

Labour market conditions are becoming more balanced across advanced economies and in some cases have eased a little faster than expected.

Unemployment rates have increased in most advanced economies, as labour demand has moderated and, in some cases, strong population growth has lifted labour supply (Graph 2.6). Large increases in unemployment rates have occurred in Canada, Sweden and New Zealand, consistent with greater slowing in activity (relative to potential growth) in these economies. With labour markets having become more balanced in most advanced economies, and vacancy rates having largely normalised, more of the easing in labour markets is now occurring through increases in unemployment rates (Graph 2.7). By contrast, labour market conditions remain tighter in Australia. Wages growth remains high in most advanced economies, in part reflecting some catch-up following earlier high inflation. Easing pressure in labour markets should help moderate wages growth, though persistently high wages growth remains an upside risk to inflation.

Disinflation has resumed in the United States in recent months, but progress continues to stall in other economies, particularly in Europe.

Year-ended inflation continues to ease in most economies. In the United States, inflation has recently eased more quickly than expected after some signs of upward inflation momentum earlier this year. Recent inflation momentum, measured by the six-month-annualised rate, is in line with the target in Canada and Sweden, consistent with more spare capacity in these economies. However, in some other advanced economies, including the United Kingdom and euro area, progress in lowering core inflation has stalled or even reversed (Graph 2.8). Notwithstanding this, the Bank of England and the European Central Bank assess recent higher core inflation rates as part of a bumpy disinflation path and expect a further decline in inflation over time as demand and supply continue to rebalance. Both central banks have emphasised that a restrictive monetary policy stance will be maintained to ensure inflation sustainably returns to target.

Core inflation has been held up by a noticeable pick-up in services inflation in several advanced economies, while goods inflation remains low. Non-housing services inflation remains high outside of Canada and has trended higher in the euro area and the United Kingdom in recent months; in part, this increase may be a lagged response to earlier cost pressures for some infrequently adjusted services prices (Graph 2.9). Rental inflation also remains high, and disinflation progress in this category has been slow. Although leading indicators such as advertised rents have started to ease, the pass-through to lower rental inflation is likely to take some time.

2.2 Domestic economic activity

Restrictive financial conditions continue to weigh on private demand, but overall domestic demand growth was stronger than expected in early 2024.

Domestic final demand growth in early 2024 was slightly stronger than expected at the time of the May Statement, driven by household consumption and public consumption. Household spending surprised to the upside in the March quarter, with spending on utilities, transport and entertainment services stronger than anticipated. Growth in public consumption was also stronger than expected in the March quarter and has increased as a share of nominal GDP over the past year (Graph 2.10). Public consumption is being supported by expenditure on social benefits to households, such as the National Disability Insurance Scheme, Medicare and the Pharmaceutical Benefits Scheme. While public investment growth was weaker in the March quarter, a large pipeline of infrastructure projects is expected to continue supporting investment.

The volume of imports of goods and services was higher than expected, resulting in weaker-than-expected GDP growth in early 2024 (Graph 2.11). Imports growth was strong in early 2024 and outpaced growth in domestic demand. Conversely, growth in exports slowed, reflecting soft spending by international students. A range of indicators suggest that the soft pace of growth in economic activity continued in the June quarter. The subdued pace of GDP growth has been helping to bring the level of aggregate demand into better balance with supply.

GDP declined further on a per-capita basis in early 2024. GDP growth was 0.1 per cent in the March quarter and 1.1 per cent over the year to March (Graph 2.12). In per-capita terms, GDP has declined by 1.6 per cent since its peak in mid-2022. In addition, Australian Bureau of Statistics’ projections in the Labour Force Survey suggest that population growth was stronger in the first half of 2024 than expected three months ago, which in turn suggests that growth in the economy on a per-capita basis has been weaker than implied by the March quarter National Accounts data.

Growth in household consumption remains well below pre-pandemic averages but has been stronger than previously thought.

Real disposable incomes have declined sharply over the past 18 months but have stabilised recently (Graph 2.13). The stabilisation in real incomes is the result of inflation declining, and a slowing in the pace of interest rate and tax payment increases. The implementation of the Stage 3 tax cuts and further declines in inflation are expected to result in real incomes growing strongly in the second half of 2024.

Household net wealth has increased steadily, which has helped to offset some of the impact of weak disposable incomes on consumption. Real household net wealth has increased by 5 per cent over the past year and is 22 per cent higher than prior to the pandemic. The increase in wealth since the pandemic has been driven by strong housing price growth, additional savings by households during the pandemic and equity price increases (see Chapter 1: Financial Conditions). Households’ holdings of liquid assets, such as deposits, have also grown much more quickly than incomes over this period.

Household consumption growth has been stronger than forecast in the May Statement. Some of the upside surprise was driven by large revisions to the level of spending by Australian tourists overseas since mid-2022, and therefore has not affected our assessment of domestic inflationary pressures. Growth in the consumption of goods and services in Australia in the March and December quarters was also a bit stronger than expected, and partial data for the June quarter, including retail sales and bank transaction data, suggest this pick-up in growth was sustained.

The revisions to consumption have lowered the household saving ratio. On both a gross and net (of depreciation) basis, the saving ratios are below their pre-pandemic levels but have been relatively stable over recent quarters. The extent to which households are willing to continue to save at this lower rate, particularly once real income growth starts to recover, represents a key uncertainty in the outlook for household consumption (see Chapter 3: Outlook).

Timely transaction-based spending data suggest that spending growth remains subdued for most households (Graph 2.14). This has been most pronounced for renters, who are typically younger. Many other households have also had to make difficult adjustments in response to the challenging conditions, such as those with limited or no financial buffers. Community service organisations report that demand for their services remains at a very high level compared with the years before the pandemic owing to cost-of-living pressures and a shortage of affordable housing.

The increase in consumption growth has been partially offset by a slowdown in services exports. Growth in spending by inbound visitors to Australia eased further in early 2024, led by a moderation in spending by international students and tourists. The ongoing recovery in inbound tourism has been slower than expected at the time of the May Statement, largely driven by Chinese tourists. In recent months, offshore student visa grants have fallen sharply as the federal government has tightened requirements for student visa applicants; the government has also proposed caps on international student numbers.

Growth in private business investment has moderated recently from the very high growth rates in 2023.

Business investment growth moderated in early 2024, by a bit more than expected, following strong growth over the prior 18 months. Non-mining construction investment fell in the March quarter, by more than expected, driven by falls in small to mid-sized projects that were mostly commenced and completed in the December quarter (Graph 2.15). However, non-mining construction investment has been supported by investment in renewable energy infrastructure, data centres, warehouses and continued progress on the pipeline of yet-to-be-done construction work, and this is expected to continue. Growth in non-mining machinery and equipment investment has slowed in recent quarters but the level of investment remains elevated. Non-mining software investment continues to grow strongly. Firms in the RBA’s liaison program report that investment continues to be supported by a backlog of light commercial vehicle orders and data centre fit-outs (see Box B: Insights from Liaison). Firms also continue to invest in software platforms and a range of other digital services relating to data migration, cloud storage and cybersecurity.

Firms expect the pace of investment growth to slow further in the year ahead and nominal investment intentions for 2024/25 have been revised down slightly. Non-mining construction is still expected to grow at a similar pace to the previous year, while non-mining machinery and equipment and mining investment are expected to be relatively flat. Firms in the RBA’s liaison program have also reported a moderation in planned investment spending for the year ahead, primarily citing higher input costs (particularly for labour), delays in non-residential construction approvals, a subdued outlook for demand and broader macroeconomic uncertainty. Similarly, information from the NAB business survey suggests that investment expectations have softened alongside elevated labour costs and a decline in forward orders.

As a share of all businesses, company insolvencies remain around their pre-pandemic average, having increased from record lows during the pandemic.

The level of company insolvencies remains below the pre-pandemic trend, despite increasing since 2022 (Graph 2.16). The increase reflects a slowing economy, the removal of pandemic support measures and the Australian Taxation Office resuming enforcement activities on unpaid taxes. Sectors more exposed to discretionary spending, such as arts and hospitality, now account for a larger share of insolvencies, while insolvencies in the construction sector have declined but remain elevated. Some construction firms in the RBA’s liaison program have suggested that margins are stable or improving, but conditions are reported to remain challenging for firms, particularly subcontractors.

Housing price growth has been stronger than expected and growth in advertised rents remains strong, as new supply continues to fall short of growth in underlying demand.

Underlying demand for housing has remained strong, but growth in demand appears to have moderated in recent months. Strong population growth and a low average household size continue to contribute to strong growth in underlying demand for housing. However, population growth appears to be past its peak and average household size has increased further in recent months, possibly in response to affordability constraints (Graph 2.17).

New dwelling supply remains weak, reflecting ongoing cost pressures affecting project feasibility and labour shortages for certain trades. Some contacts in the RBA’s liaison program have suggested that high building costs are limiting the viability of many higher density projects at current prices, contributing to low numbers of building approvals and commencements. Labour shortages for certain trades, particularly finishing trades for higher density construction, are still contributing to new dwelling cost inflation and limiting progress in reducing the backlog of work to be done (Graph 2.18). Nonetheless, contacts report that weak new home sales have contributed to easing labour shortages for earlier stages of the detached housing construction process.

The ongoing imbalance between supply and underlying demand has led to further rises in housing prices and rents. National housing price growth has been stronger than expected over recent months (Graph 2.19). Price growth has remained stronger for less expensive properties within capital cities and property types. Growth in advertised rents has eased over recent months, which may reflect the impacts of affordability constraints and is consistent with the recent increase in average household size. Nonetheless, it remains above the growth rates experienced prior to the pandemic.

2.3 Labour market and wages

Labour market conditions have continued to ease gradually but recent data suggest there is less capacity than previously thought.

The easing in labour market conditions since late 2022 has occurred through a gradual increase in the unemployment rate, alongside declines in vacancies and average hours worked. The unemployment rate increased as expected to 4.1 per cent in June, 0.6 percentage points above its late-2022 trough (Graph 2.20). The unemployment rate remains below estimates of the rate consistent with full employment, and we now assess that there is less capacity than previously thought, consistent with high prices and wages outcomes over the past year (see section 2.5 Assessment of spare capacity). More cyclical measures of unemployment, such as the medium-term and youth unemployment rates, and the hours-based underutilisation rate – a broader measure of spare capacity – have also increased but remain low relative to pre-pandemic levels.

Vacancies have fallen from their 2022 peak but remain further above their pre-pandemic levels than in peer economies (Graph 2.7). The relatively high level of vacancies is consistent with an elevated share of businesses reporting in surveys that suitable labour remains a constraint on output and indicates that the labour market remains relatively tight. Average hours worked have declined over the past year, owing largely to a decrease in the average hours worked by full-time workers and an increase in the share of part-time workers. More recently, average hours have been stronger than expected, and are slightly higher now than six months earlier.

Data on labour market flows suggest firms are responding to weaker demand mostly by hiring fewer additional workers rather than by laying off staff. While the rate of layoffs has increased modestly since 2022 alongside the gradual easing in labour market conditions, it remains low.

Employment growth has moderated but remains solid and is now around the same pace as working-age population growth. Employment growth in the June quarter was stronger than previously expected, consistent with population estimates being stronger than assumed. Accordingly, the employment-to-population ratio has remained near its historically high level. Employment has increased by around 240,000 persons since the start of 2024. Taken together, developments in average hours worked and employment suggest the demand for labour, in aggregate, has recently been stronger than previously expected. The labour force participation rate remains high and is slightly above its level in late 2022, supported by greater participation by females and older workers (Graph 2.21).

Aggregate employment outcomes have been supported by employment growth in industries that are typically less sensitive to the business cycle, including health care and education (Graph 2.22). By contrast, employment outcomes in more cyclical sectors, such as retail trade and hospitality, have slowed in recent quarters. Employment intentions of firms in the RBA’s liaison program remain positive but have eased to be slightly below their long-run average.

Productivity growth remains weak.

Non-farm labour productivity increased by 0.4 per cent over the year to the March quarter. Employment growth fell in the pandemic and rose sharply afterwards. As the capital stock takes time to adjust, this caused the capital-to-labour ratio and labour productivity to rise and then fall. The capital-to-labour ratio is now reverting to its pre-pandemic level, supporting the level of labour productivity (Graph 2.23). Multifactor productivity growth, which is the part of labour productivity growth not due to growth in the capital-to-labour ratio, remains weak. Looking through pandemic-related volatility, labour productivity is now around the same level as in 2016. Productivity outcomes have been weak in most market and non-market industries over the past few years, though especially in the mining and utilities industries.

Wages growth appears to have passed its peak but remains higher than can be sustained by the trend growth rate of productivity.

Growth in the Wage Price Index (WPI) has been elevated over the past year, though it eased in the March quarter to 4.1 per cent. This easing in wages growth was broadly based, and growth in enterprise agreements was weaker than expected (Graph 2.24). The Fair Work Commission’s recently announced 3.75 per cent increase to modern award wages, effective from 1 July, will also see a step down in award-linked wages growth. The proportion of jobs receiving a wage change has eased a little relative to a year ago, though the average size of wage changes remains large.

WPI growth remains faster than can be sustained by trend growth in productivity without putting upward pressure on inflation. When productivity growth is positive, WPI is able to outpace inflation while still being consistent with inflation in the middle of the inflation target band. As trend growth in labour productivity is below its rate in previous decades, the sustainable WPI growth rate is lower than in the past and below the current rate of growth. In the short term, WPI growth could exceed the sustainable rate – for example, to catch up to a previous period of high inflation. However, we assess that the current pace of wages growth cannot be sustained in the long term without a higher pace of trend growth in productivity.

Unit labour cost growth is moderating gradually, but it remains higher than is consistent with inflation being sustainably at the midpoint of the target range.

Year-ended unit labour cost growth has remained high. Unit labour costs, which are labour costs adjusted by labour productivity, grew by 5.7 per cent over the year to the March quarter, well above its historical average pace (Graph 2.25). A lower pace of growth in unit labour costs is required for inflation to sustainably remain at 2.5 per cent in the long run.

2.4 Inflation

Inflation remains above target and the pace of disinflation has slowed.

Headline inflation remained high in the June quarter. Headline CPI increased by 1.0 per cent in the June quarter to be 3.8 per cent higher over the year, up from 3.6 per cent in the March quarter (Graph 2.26). The increase in headline inflation was driven, in part, by a strong increase in the prices of overseas travel and volatile items.

Measures of underlying inflation – which remove the effect of short-term volatility in a subset of prices – eased in the June quarter; trimmed mean inflation was 0.8 per cent in the quarter and 3.9 per cent over the year (Graph 2.27). This outcome was broadly as expected at the time of the May Statement. The recent slow pace of disinflation is consistent with the assessment that the labour market remains tight and aggregate demand continues to exceed supply.

Services inflation is easing from a high level.

Market services inflation eased in the June quarter. Market services inflation was 0.9 per cent in the June quarter and 5.3 per cent over the year, down from 6.4 per cent (Graph 2.28). The easing in year-ended inflation was broadly based across most market services, particularly those that are more discretionary, such as eating out and recreational activities. However, services inflation remains well above its historical average, consistent with the significant pace of growth in domestic non-labour costs and unit labour cost growth. Survey measures, including in the RBA’s liaison program, suggest that firms are continuing to pass through much of this cost growth to prices, although soft consumer demand has made pass-through more difficult in some industries.

Rent inflation remains high and this is expected to persist. Rent inflation – for the stock of rental accommodation captured in the CPI (which excludes regional areas) – was 2.0 per cent in the quarter and 7.3 per cent over the year (Graph 2.29). The slight easing in quarterly rents inflation was due to the regular indexation of Commonwealth Rent Assistance. Growth in advertised rents remains high, reflecting tight rental market conditions across the capital cities; however, it has started to ease recently, consistent with the increase in average household size. Rents on new leases flow through to CPI rents with a lag as only a small share of the stock of rental properties update leases in a given month, which implies that CPI rents inflation is likely to be high for some time.

Inflation for goods and services with administered prices was slightly above its long-term average in the June quarter. Inflation in the prices of ‘administered items’, which are (at least partly) regulated or relate to items for which the public sector is a significant provider, picked up in the June quarter in year-ended terms. Key contributors to this pick-up were increases to health insurance premiums, as well as to electricity prices as some energy rebates unwound. Although these prices are affected by government policies, many services such as education and medical services are labour intensive and therefore are sensitive to growth in labour costs. Recent inflation in administered prices has also reflected an upward contribution from past high CPI outcomes, as some administered prices are influenced by indexation to the CPI. Nevertheless, inflation in administered items remains only a little above its long-run average. By contrast, inflation in the rest of the CPI basket is well above its average over the inflation-targeting period (Graph 2.30).

Goods inflation continued to ease, though at a slower pace than previously.

Goods (excluding volatiles) inflation continued to ease, although the pace of disinflation appears to have slowed. This is consistent with the earlier easing in price inflation of imported consumption goods having largely flowed through to domestic prices. The recent increases in shipping costs have elevated the risk of future disruptions, but most firms in the RBA’s liaison program report that supply chains are largely operating as normal so far. Nonetheless, domestic labour and non-labour costs (including electricity, insurance, and warehousing and logistics rents) continue to place some upward pressure on goods prices (Graph 2.31).

Consumer durables inflation was around zero in the year to June. Lower price growth for these items is likely to have been supported by intensified cost discipline, with some firms in the RBA’s liaison program reporting that a variety of approaches have been used (e.g. re-evaluating expenses and pushing back on supplier cost increases) to moderate cost and price growth. Groceries inflation continued to ease in year-ended terms (Graph 2.32).

New dwelling cost growth has stabilised at a high level, above its pre-pandemic rate. Labour costs and some energy-intensive materials are driving ongoing cost growth, partly driven by the large pipeline of work and ongoing labour shortages for certain trades (see section 2.2 Domestic economic activity).

2.5 Assessment of spare capacity

Our overall assessment is that the labour market and broader economy are tighter than previously thought.

We previously judged the level of full employment to be a bit higher than prior to the pandemic, reflecting possible changes in the labour market such as increased capacity for workers to work remotely or the decline in the share of long-term unemployed. Temporary supply-side factors were also thought to be having a larger-than-usual influence on inflation and wages outcomes. Some of these factors have now abated and labour demand has eased, but disinflation has been slow and wages growth has remained persistently high relative to labour productivity outcomes. Given these developments, we assess the labour market and broader economy to be tighter than previously thought. Our assessment is consistent with a variety of indicators and information from the RBA’s liaison program that suggest utilisation of labour and other inputs have remained above historical averages. Model-based estimates of spare capacity also suggest the gap between demand and supply is larger than thought at the May Statement.

Labour market and capacity utilisation indicators suggest economic conditions remain tight.

A range of labour market indicators suggest the labour market remains tight but has eased further in recent months. Many indicators remain tight relative to their typical range of outcomes over the past two decades (Graph 2.33). Both the ratio of vacancies to unemployment and the share of firms reporting labour availability as a constraint on output continue to be well above pre-pandemic levels, despite declining from their 2022 peaks. Employment growth and average hours worked have eased by less than anticipated, and the labour force participation rate remains near record highs. Measures of labour underutilisation have increased but only gradually. The moderation in the labour market since late 2022 has been most evident in leading indicators, such as employment intentions, labour flow indicators and the hires rate – that is, the number of hires as a share of filled jobs.

Indicators of capacity utilisation suggest some resources continue to be utilised intensively in the economy. Since the May Statement, the easing in survey measures of capacity utilisation appears to have stalled (Graph 2.34). Capacity utilisation for goods industries has ticked up in the past three months, while capacity utilisation for all industries has stabilised above the historical average over the first half of 2024. This suggests businesses are still using their labour and capital resources at higher-than-normal rates to meet demand. Vacancies data also shows the housing stock continues to be utilised intensively. Residential vacancies remain low as new supply of housing continues to fall short of growth in demand, putting upward pressure on residential rents. These outcomes – combined with tighter labour market conditions, the slow pace of disinflation, and wages growth that is higher than productivity outcomes – all point to a greater imbalance in the economy than previously thought.

Model estimates of the gaps between demand and supply in the economy are larger than we had previously assessed.

Model-based estimates also suggest that the labour market has remained tighter than full employment, in line with elevated wages growth and high inflation (Graph 2.35). Both the unemployment rate and the broader hours-based underutilisation rate remain lower than estimates of rates that are consistent with full employment, resulting in negative unemployment and underutilisation gaps. These gaps have narrowed over the past year, suggesting the labour market is gradually moving towards full employment. However, estimates of the gaps are wider than assessed in the May Statement, reflecting elevated prices and wage outcomes over the past year that are consistent with more tightness than previously thought. There is substantial uncertainty surrounding estimates of full employment, although each of the model estimates in the suite that we consider implies that the labour market is tighter than full employment.

A range of model-based estimates suggest the output gap is positive but continues to narrow. Recent outcomes for actual output remain higher than estimates of potential output, suggesting aggregate demand continues to exceed the capacity of the economy to sustainably produce goods and services. Estimates indicate the output gap continued to narrow in the March quarter, reflecting subdued growth in output relative to potential (Graph 2.36). However, the range of output gap estimates is slightly higher and wider than assessed at the May Statement, suggesting more excess demand in the economy than previously thought, and greater uncertainty. The higher output gap estimates reflect tighter labour market conditions as discussed above, and inflation outcomes over the past year that are consistent with a higher output gap. The range of estimates is wide, reflecting differences in how models interpret these developments and their effect on potential output and the output gap.