Economic Outlook: How Are Things Shaping Up?

Warren Hogan, Chief Economic Advisor, Judo Bank

Why has forecasting rates been so difficult? 

• In January 2023, 2/35 economists expected the RBA cash rate to be 4.35% or higher in June 2024. The median forecast was 3.1%. 15/35 expected it to be 2.85% or lower. 

• Economists totally underestimated need for rates to go up, and when they would go down because: 

  • The economy has fundamentally changed as we have passed through a long-term demographic turning point (supply/demand balance shift). 

  • Expectations are based on GFC to Covid period. 

  • Politicisation of monetary policy. 

  • Herding around the market consensus. 

The economy has fundamentally changed 

• Rising dependency (people who don’t work) has resulted in our labour shortage not population growth – a fundamental shift in the economy.  

• Result – labour shortages are clearly indicated by high level of job vacancies across the economy. This results in the fundamental supply/demand imbalance. 

Pandemic inflation shock  

• All inflation episodes start with a shock – this time it was lockdowns and surging demand for goods. Shock from lockdowns led to a surge in demand for goods,which led to increase in goods prices, compounded by fiscal stimulus. 

• After a shock, if with fundamental economic shift isn’t dealt with, traditional inflation occurs. 

• Significant lags between these effects and the inflation battle is not yet won (contrary to IMF).  

Domestic economy

• Slowdown in Australian economy is due to a squeeze on households from inflation (70% of it). Consumption growth stalled to virtually zero in FY24.

• GDP growth has slowed to 1% over the past year while employment growth is almost 3%.

• The economy is not nominally weak, but if Australia has had average productivity growth, Australia would have much higher GDP growth (such as in the U.S. where there is 3% growth).

• Next 5 weeks will be critical – a bounce back in consumer spending could spark an economic upswing in 2025. This could define where the economy goes next year.

Australia’s monetary policy is not ‘tight’ (restrictive)

• Economic activity (real GDP growth) is expected to accelerate in FY25 as real interest rates stabilise around 1%, suggesting financing costs are low in real terms.

• The US Federal Reserve can cut rates because they did greater monetary policy tightening, with a real interest rate above 2%.

• However, cutting for the RBA now would be irresponsible.

Inflation coming down, but will it stay down (Australia)?

• Looks to be on track to decline in line with the RBA’s expectations, but not a done deal.

• Wage price index (WPI) has dipped to a 3.5% annual growth rate over the year to September.

• The economy not going through wage price spiral – but rather a productivity doom loop.

Where to for interest rates?

• Market expecting 3 rate cuts starting from May 2025. Market consensus and pricing has converged on this highly politicised prediction (close to an election).

• The EQ economics central forecast is for two cuts (60bps) commencing in November 2025 – but the risk scenario includes a hike in May.