Statement on Monetary Policy – August 20243. Outlook

3.1 The global outlook

Growth in Australia’s major trading partners is expected to be moderate.

Year-average GDP growth for Australia’s major trading partners is expected to be around 3.3 per cent in 2024 and 2025 (Graph 3.1). The 2024 forecast is a little higher than was forecast three months ago; the 2025 forecast remains unchanged. A larger weight on China from the annual updates to the export shares in the growth of our major trading partners has lifted the forecast for 2024; revisions to economy-level forecasts are largely offsetting in aggregate and reflect actual outcomes in the first half of the year. Stronger-than-expected growth to date across high-income east Asia has offset slightly weaker growth forecasts for the G7 economies and China than expected three months ago.

Forecast year-average GDP growth for China for 2024 is 4.8 per cent, slightly lower than previously forecast. The downward revision reflects weaker-than-expected GDP data in the June quarter and a worsening outlook for consumption and real estate investment, which have been partly offset by an improved near-term outlook for exports. This is still consistent with authorities’ target for year-average growth of ‘around 5 per cent’ this year. Forecast growth for 2025 is unchanged from three months ago; growth is expected to slow to 4.3 per cent as growth in investment and exports weakens. The risks to Chinese growth remain tilted to the downside, given the weak sentiment in the property sector, the effect of ongoing strains in local government finances on infrastructure investment and any possible further increase in trade barriers.

Year-average GDP growth is forecast to increase gradually in many advanced economies over the forecast period, while growth in the United States is expected to continue to moderate. This forecast profile is unchanged from the May Statement, though there have been some offsetting revisions at the economy level to the near-term outlook that largely reflect March quarter GDP outcomes. Demand conditions are forecast to improve in most economies over the forecast period, led by growth in household consumption as real incomes continue to recover and as financial conditions ease.

Inflation is expected to continue to ease in advanced economies; while some recent inflation outcomes have surprised to the downside, persistent services inflation and a sharp rise in shipping costs pose upside risks.

Progress in lowering inflation has resumed in the United States and has also surprised to the downside in recent months in some other economies (including Canada and New Zealand). This has raised the prospect of a faster easing in inflation. By contrast, services inflation remains high in many economies and has recently increased further in the euro area and the United Kingdom; while central forecasts are still for further easing, this highlights the risk that disinflation progress could be slower than expected. Recent increases in shipping costs and a further escalation in trade or geopolitical tensions pose additional upside risks to goods inflation.

The expected timing for inflation to sustainably return to target continues to vary across economies but has been little changed since the May Statement. In the past three months, some central banks have cut policy rates and expectations for monetary policy easing have been brought forward in most advanced economies (see Chapter 1: Financial Conditions). The Riksbank and Reserve Bank of New Zealand expect headline inflation to return to target this year, while the Bank of Canada and the European Central Bank expect inflation to be at target in 2025. Most other central banks expect inflation to be around target in 2026.

3.2 Key domestic judgements

The central forecasts incorporate many judgements, such as the choice of models used and whether to deviate from the models given the signal from recent data or qualitative information from liaison. These judgements are considered and debated extensively throughout the forecast process. The three most important judgements for the staff’s current assessment of the economic outlook are discussed below.

Key judgement #1 – There is more excess demand in the economy and labour market than previously assessed.

Estimates of how far the economy is from potential output or sustainable full employment are important inputs for wages and prices forecasts. However, as has been previously noted, there is a great deal of uncertainty around estimates of full employment.

Using information from model-based estimates, outcomes for wages growth and inflation and a range of labour market indicators, staff now assess that the level of full employment that the economy can sustain without creating undue inflationary pressures is lower than previously thought. While it is possible that changes in the labour market observed over recent years – such as lower levels of long-term unemployment and more flexible work arrangements – could contribute to a higher level of full employment, the evidence that these will be sustained is mixed. Inflation outcomes have been stronger than can be explained by our previous estimates of excess demand, and wages growth has been high relative to productivity outturns (even excluding the very strong award wages growth in September 2023).

This suggests that the economy and labour market have been further away from potential output and full employment than previously thought. All else equal, this starting point of greater imbalance between aggregate demand and supply implies that it will take longer for inflation to return to target. However, there is considerable uncertainty around this judgement, as explored in the risks section below.

Key judgement #2 – Household consumption is around a turning point and will increase in line with its historical response to changes in real incomes and wealth.

In per capita terms, consumption is expected to rise from the second half of 2024 after having fallen for the past 18 months. In making this judgement, the staff have taken signal from the upward revisions to consumption that were included in the March quarter National Accounts. The revised path for consumption is broadly consistent with past developments in household income and wealth (prior to the revisions, consumption appeared much weaker than implied by these relationships) and suggests that households have been willing to maintain a lower rate of saving than previously assessed. Both real household income and wealth are expected to grow strongly over the forecast period; real household disposable income growth is expected to increase notably from mid-2024 as a result of the Stage 3 tax cuts and further declines in inflation.

The consumption outlook is a key area of uncertainty given the recent data revisions and the experience in peer economies where consumption has been slow to recover despite an earlier increase in incomes. Risks around the expected recovery of consumption are discussed in detail below.

Key judgement #3 – The labour market will continue to ease at a gradual pace but will stabilise following the pick-up in GDP growth.

The unemployment rate is forecast to increase gradually over the next year, in line with past downturns of similar magnitude. But there are other margins of adjustment in the labour market, such as the number of hours that employees work and the number of vacancies advertised.

We expect that the adjustment to easing labour demand will continue to occur through lower vacancies and average hours, where firms will tend to hire fewer people rather than reduce existing headcount. This judgement is based on the fact that it is difficult to find evidence of a rapid deterioration of labour market conditions. Indicators of labour demand, such as job vacancies, have declined but remain at high levels. The hiring intentions of firms surveyed in the liaison program have softened but are only slightly below average. And while unemployment could rise sharply if businesses have hoarded labour and reach a tipping point, there is little evidence of this: survey measures of capacity utilisation remain above average and vacancies and average hours are at or above their long-run trends.

The risks that the unemployment rate could increase more rapidly, or not rise as much as forecast, are explored below.

3.3 The domestic outlook

GDP growth is projected to pick-up from mid-2024 as growth in household consumption and public demand support activity.

The outlook for GDP growth in 2024 is similar to three months ago (Graph 3.2). Imports growth was much stronger than expected in the March quarter and this has offset a stronger near-term outlook for public demand and household consumption growth relative to three months ago.

The near-term upgrade to household consumption growth is consistent with stronger-than-expected outcomes in early 2024 and partial indicators, and largely reflects upward revisions to population growth in the first half of 2024. Overall, growth in private demand is expected to remain subdued for the rest of 2024 because of restrictive financial conditions. The forecasts are conditioned on a cash rate path derived from financial market pricing; it is assumed that the cash rate has already peaked, with market pricing implying little chance of a further increase. A 25 basis point reduction in the cash rate is fully priced in by early 2025, and the cash rate is expected to decline to around 3.3 per cent by the end of 2026.

Growth in GDP is expected to increase further in 2025, reflecting stronger than previously forecast public spending and a previously anticipated pick-up in household consumption growth. Relative to three months ago, GDP growth has been revised up in the year to mid-2025, with an upgrade to public demand growth partially offset by stronger growth in imports and weaker dwelling investment growth. The stronger outlook for public demand reflects ongoing spending and recent announcements by federal and state and territory governments.

Household consumption growth is expected to return to around its pre-pandemic average by mid-2025, supported by an increase in real income growth from the Stage 3 tax cuts and declining inflation, as well as higher wealth (Graph 3.3).

The forecast recovery in dwelling investment growth is expected to occur later than expected three months ago. This reflects the signal taken from further weakness in the data in early 2024 and messages from the RBA’s liaison program on growing feasibility challenges in higher density construction. Dwelling investment is expected to pick up from late-2025, supported by increasing demand for new housing as sentiment improves. Business investment growth is expected to be supported by the large pipeline of infrastructure work, digitisation and the renewable energy transition; the outlook for business investment is similar to three months ago. Exports growth is expected to be solid for most of the forecast period. The downside risks to the outlook for new international student arrivals have increased since May (see Chapter 2: Economic Conditions). However, if these risks were to materialise, they would detract from both the demand and the supply side of the economy as many students participate in the labour force.

Demand and supply will move closer to balance over the forecast period.

It is estimated that there is more excess demand in the economy than previously thought, but the gap is expected to narrow over the forecast period. This will bring the economy to a more balanced state. Over the next six months, subdued growth in aggregate demand is expected to bring demand and supply closer to balance. After which time, the output gap is expected to narrow more gradually, reflecting an expected increase in GDP growth, while potential output is assumed to grow by around 2½ per cent. The staff’s assumption for potential output growth reflects a decline in population growth from its current high rate being offset by a gradual increase in trend productivity towards its pre-pandemic rate. However, there is considerable uncertainty around these assumptions as well as when the output gap will close.

The labour market is expected to ease further over the next year before stabilising at a level closer to full employment estimates.

Labour underutilisation rates are expected to rise further over the next year alongside subdued growth in economic activity, before stabilising in 2026 (Graph 3.4). The unemployment rate is forecast to increase further over coming quarters, reflecting the continued easing in leading indicators of labour demand such as job vacancies and hiring intentions. However, this increase is expected to be gradual, consistent with the mildness of the current downturn. Some of the labour market adjustment to subdued economic growth over the past year has occurred through a decline in vacancies and average hours worked; as discussed above, it is judged that this pattern will continue over the coming year. Following the pick-up in GDP growth from 2025, the unemployment rate is expected to stabilise around its peak.

Employment growth is forecast to be below working-age population growth for a time, contributing to the forecast gradual increase in the unemployment rate in the coming quarters. Participation in the labour force is expected to be sustained around recent high levels. Longer run trends of increased participation by females and older workers are likely to continue supporting the participation rate, with some offsetting effects from the cyclical slowing in the economy, although there is continued uncertainty around which of these effects will dominate.

Growth in nominal wages is expected to moderate somewhat as the labour market eases.

Wages growth looks to be past its peak and is expected to continue to slow gradually as the labour market eases. Wages outcomes in the March quarter eased a little and point to a softer pace of growth over 2024 (Graph 3.5). The Fair Work Commission’s recently announced 3.75 per cent increase to modern award wages, effective from 1 July, will see a step down in award-linked wages growth compared with the previous year. Wages growth is forecast to continue to ease gradually as the labour market eases. However, the pace of nominal wages growth is expected to remain high relative to productivity growth. Real wages are forecast to increase over the forecast period as the pace of nominal wages growth declines more slowly than inflation.

Growth in unit labour costs is expected to moderate over coming years. Growth in nominal unit labour costs – the measure of labour costs most relevant for firms’ cost of production and so for inflation outcomes – is forecast to ease as nominal wages growth gradually eases and labour productivity growth picks up (see discussion below). If productivity growth does not pick up as assumed, nominal unit labour costs would remain a little above the rate consistent with inflation being sustainably at the midpoint of the target throughout the forecast period.

Labour productivity growth in 2024 is expected to be weaker than previously anticipated, though there is significant uncertainty around its outlook. The weaker outlook for productivity growth largely reflects a more gradual easing in growth in average (and total) hours worked. The outlook further out is little changed. Productivity growth is assumed to pick up and then stabilise around its long-run (excluding the pandemic) average rate over the forecast period. The pick-up in labour productivity growth mostly reflects a pick-up in multifactor productivity growth (MFP) (i.e. output growth from combining labour and capital input in better ways) (Graph 3.6). This pick-up could arise from a variety of sources, including increased rates of technology adoption, improved reallocation of labour between low- and high-productivity firms, improved labour quality and improved quality of job matching.^[1] It is estimated the large inflow of less experienced entrants into the workforce who require more time to learn and upskill had a small negative effect on MFP growth in recent years. Any future changes in labour quality or the quality of job-matching outcomes are assessed to not have a substantial effect on MFP growth over the forecast period. The outlook for productivity – which is a key determinant of the economy’s supply capacity, real incomes and hence living standards – is highly uncertain.

Underlying inflation is expected to return to the target range a little slower than previously forecast.

Underlying inflation is expected to ease more gradually than previously anticipated, falling below 3 per cent by late 2025 and approaching the midpoint of the band in 2026. The forecast for underlying inflation (as measured by trimmed mean inflation) is little changed in the near term compared with forecasts from the May Statement, with the June quarter inflation data confirming that the pace of disinflation has slowed. Relative to the May Statement, the forecast for underlying inflation has been revised higher from mid-2025 to reflect the assessment that there will be a little more excess demand in the economy than previously estimated (Graph 3.7). Inflation expectations are assumed to remain consistent with achieving the inflation target.

Headline inflation is expected to dip below 3 per cent in the next year due to the government’s cost-of-living measures (Graph 3.8). New and extended electricity rebates and increases to rent assistance are expected to subtract around 0.6 percentage points from year-ended headline inflation in the September quarter of 2024. However, the legislated unwinding of some policies in 2025 will push headline inflation to back above the target range before converging towards underlying inflation once these temporary factors have passed (see Box C: Headline and Underlying Inflation).

Services inflation remains high and is expected to decline only gradually over the coming year. Strong domestic cost pressures (both labour and non-labour inputs) have kept inflation outcomes high in recent quarters. Services inflation, such as in recreation and leisure services, is expected to ease only gradually as growth in input costs and demand moderates over the forecast period. The more gradual decline in services inflation relative to the earlier decline in goods inflation is in line with trends overseas. The experience abroad highlights the risk that services inflation could be more persistent than expected. Inflation of administered items (excluding utilities), which tend to have a higher rate of inflation than other components of inflation, are expected to remain fairly elevated over the forecast period.

Housing inflation is expected to remain high over the forecast period. Information from liaison is consistent with new dwellings inflation remaining higher for longer than previously expected, owing to ongoing capacity constraints in the construction sector alongside shortages for skilled trades. Rent inflation is expected to remain high over the forecast period; advertised rents growth remains elevated and it will take some time for increases in housing supply to flow through to rental prices on new leases and subsequently on the stock of rental properties. The increase in average household size, as seen in recent months, will alleviate some of the pressure on rental prices (see Chapter 2: Economic Conditions).

Goods inflation has eased and is expected to stabilise at a relatively modest pace over the forecast horizon. The earlier easing in imported inflation as global supply chains normalised last year has largely flowed through to domestic goods prices. Growth in domestic labour and non-labour costs is moderating (though both remain high), and information from liaison suggests retailers face pressure to contain price growth given subdued demand. That said, recent increases in shipping costs are a key risk to the outlook for goods inflation, although retail firms in liaison are yet to report that shipping costs are flowing through to their costs. Nonetheless, if shipping costs remain at their current high level, our estimates suggest this could add ¼ percentage point to inflation after about a year.

3.4 Key risks to the outlook

The risks to the domestic outlook for activity and inflation are broadly balanced, though the costs associated with the risks differ.

Persistent inflation outturns above target pose significant economic welfare costs to the Australian public, particularly those households with lower incomes that typically have smaller financial buffers. And inflation outcomes that are consistently above target risks a drift higher in inflation expectations, which would likely require more monetary policy tightening and a sustained and costly period of higher unemployment to reset inflation expectations and bring inflation back to target.

On the other hand, a materially weaker economy and labour market would likely see a faster return to the inflation target – however, this would be accompanied by a cost to the employment objective. A sustained period of excessive spare capacity in the labour market can have permanent effects on the workers who lose their jobs during these periods.

While we view the risks to the outlook overall as balanced, there is considerable uncertainty in the current environment. We use scenario analysis to highlight some potential risks to the key judgements underpinning the outlook. Some of the scenario analysis is undertaken using the RBA’s main macroeconometric model (MARTIN).

Key risk #1 – There is more excess demand in the economy and labour market than currently assessed, meaning that the disinflation progress will stall.

The staff judge that even with the latest revision, it is more likely the current estimates of full employment overstate the amount of capacity in the labour market – that is, the level of unemployment that can be sustained without causing an increase in wages growth and inflation may be higher than currently estimated. Within the suite of models and indicators used to assess spare capacity, there is growing evidence that the labour market is even tighter than the staff currently assess. This implies further inflationary pressure and an increasing risk that the economy will not move into balance.

Alternatively, the recent high wages growth and inflation outcomes may be more transitory than previously thought, potentially because it has taken longer for the supply disruptions from the pandemic period to pass through, and/or because there have been structural changes in the labour market that allow a higher level of sustainable full employment.

Key risk #2 – The period of subdued consumption growth could be more persistent, or the recovery in consumption could be much stronger.

We see the risks to household consumption growth as balanced; however, different outcomes from the central forecast have a material effect on unemployment and inflation.

The expected recovery in consumption growth is judged to get underway in the second half of 2024. Two illustrative scenarios on the risks to consumption growth can be explored around the central forecast (Graph 3.9; Graph 3.10). In the ‘lower consumption’ scenario, consumption per capita is assumed to not grow at all over the forecast period. As per capita real household income is expected to grow strongly over the forecast period, this scenario implies that households save all of their growth in income. This would lead to GDP growth that is ½ percentage point lower over each of 2025 and 2026, resulting in an ongoing upward trajectory in the unemployment rate, but inflation would decline faster than in the central forecast.

In the ‘higher consumption’ scenario, it is assumed that most of the growth in income over the forecast period is spent. This could occur if a greater share of households have become liquidity constrained in recent years, or because households are willing to save less out of their current income following the significant increases in wealth since the onset of the pandemic. This would see the unemployment rate decrease from early 2025 back towards its current low level, but progress in reducing inflation to the midpoint of the inflation target would stall.

Key risk #3 – The labour market could deteriorate by more than expected.

The increase in the unemployment rate is expected to be a little greater than previously expected, but to remain gradual. Two illustrative scenarios can be explored around the central forecast (Graph 3.11). In the ‘higher unemployment’ scenario, the unemployment rate could respond to the current period of subdued growth more substantially than expected. A sharper rise in the unemployment rate could occur if many firms currently have an excess of staff as a result of hoarding labour, or if the easing in the labour market via hours or vacancies adjustment has now run its course. This would see unemployment rise more than expected, leading to a period of spare capacity in the labour market. This unemployment rate profile is closer to the median market economist forecast. If this played out, inflation would decline faster than currently forecast.

Alternatively, in the ‘lower unemployment’ scenario, the labour market may be stronger than forecast, pushing out the return of inflation to the target. Vacancies may remain above average, indicating that labour demand is holding up. The forecast pick-up in GDP growth could mean unemployment rises by less than expected if it is assumed that the usual relationship between GDP growth and unemployment holds over the forecast period. Moreover, if labour productivity is weaker than expected, more labour will be required for a given GDP profile. A smaller rise in the unemployment rate would mean that there would still be excess demand in the labour market, and it would take much longer to reach the midpoint of the inflation target.

3.5 Detailed forecast information

The RBA forecasts reflect our best estimate of future economic outcomes and are published every quarter. The forecasts use a combination of single-equation models, leading indicators (for nowcasts and the near term) as well as applying appropriate judgement to incorporate information that cannot easily be captured by models (e.g. information from the liaison program or large shocks such as the pandemic). These forecasts are evaluated thoroughly during the forecast process to ensure they are internally consistent and produce a clear economic narrative. The full-system economic model (known as MARTIN) is run in parallel and used as a consistency check on the forecasts.

The forecasts incorporate several technical assumptions, which were finalised on 31 July:

• The cash rate is assumed to move in line with expectations derived from financial market pricing. At the time of the finalisation of the forecasts, the cash rate was assumed to have already peaked, with market pricing implying little chance of a further increase. A 25 basis point reduction in the cash rate is fully priced in by early 2025, and the cash rate is expected to decline to around 3.3 per cent by the end of 2026. This cash rate path is lower than at the time of the May Statement.
• The exchange rate is assumed to be unchanged at its current level, which is 1.1 per cent lower on a trade-weighted basis than at the time of the May forecasts.
• Crude oil prices are assumed to be broadly unchanged around their current levels for the rest of the forecast period, which is around 6.2 per cent lower than at the time of the May forecasts.
• Although population growth is past its peak, the assumed level of the population has been revised higher based on recent ABS projections. Migration policy changes are expected to provide some offset over the forecast period, with year-ended population growth expected to decline back to its pre-pandemic average of around 1½ per cent by mid-2025.

Table 3.1 provides additional detail on forecasts of key macroeconomic variables. 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

Endnote

See Bruno A, J Hambur and L Wang (2024), ‘Measuring Labour Quality in (Closer to) Real Time Using Emerging Microdata Sources’, Paper for Joint ABS-RBA Conference on Human Capital, June; Wiley G and L Wang (2024), ‘Skills Match Quality Following the COVID-19 Pandemic’, RBA Bulletin, July. [1]