The new financial year has kicked off with the economy still weak, unemployment rising and inflation set to fall to the RBA’s 2 to 3 per cent target. It is a mix of conditions that the RBA was aiming for with its aggressive interest rate hiking cycle over the past two years.
Having said that, it needs to be careful of over-achieving – that is, driving the economy into a hard-landing in other words.
The theme for businesses and policy makers alike is negotiating the current period of weak economic activity. Keeping things afloat until there is a pick-up in activity later in 2024 and into 2025 is critical and the income tax cuts from 1 July are likely to help consumer finances.
Financial markets continue to price in a faint possibility of an interest rate increase in the next few months yet continue to embrace a series of interest rate cuts through 2025. Upcoming news on inflation and unemployment will determine the interest rate outlook.
Global economic conditions continue to weaken and interest rate cuts have been delivered (or are priced in) in all major markets including the US, the Eurozone, China, Canada, the UK and New Zealand. The main issue for debate is the timing and magnitude of those cuts.
The data on Australian economic activity remain mediocre: while retail sales rose 0.6 per cent in May, this follows several months of weakness such that the level of spending is still lower now than in November 2023. Retail sales are forecast to fall in real terms in the June quarter.
Similarly, the number of residential building approvals edged up in May but were only marginally above an 11 year low. Residential construction activity remains significantly below the level required to meet housing demand from strong population growth.
Inflation continues to be a dominant talking point for economists and the RBA with the monthly inflation rate rising, in annual terms, to 4.0 per cent in May from 3.6 per cent in April. The uptick was driven by price increases in tobacco, insurance, petrol, holiday travel and rents. While inflation is still well below the December quarter 2022 peak of 7.8 per cent, the RBA has indicated that it would prefer it to fall to the target of 2 to 3 per cent more quickly. Inflation was cited as to why the RBA gave consideration, albeit cursory, to hiking interest rates at its June meeting.
Labour market conditions remain fragile. In trend terms, employment growth is now falling below the rate of population growth which has seen the unemployment trend up from a low of 3.5 per cent in 2023 to 4.1 per cent in June. Worryingly, the number of job vacancies has fallen for eight consecutive quarters to be down 26 per cent from the peak – this is pointing to further significant increases in the unemployment rate in the year ahead.
Business confidence, which was resilient through to the middle of 2023, is now trending lower which is concerning for the medium term outlook. Firms are reporting a softening in profits, sales, forward orders and labour hiring intentions.
The trend for unemployment is likely to be a dominant issue for interest rates in the months ahead. Current forecasts are for the unemployment rate to peak around 4.25 to 4.5 per cent. At the upper end of this range, or higher, the RBA will embark on an interest rate cutting cycle.
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