Statement on Monetary Policy – August 2024Overview

Key messages

Inflation remains above target and is proving persistent.

Inflation continues to moderate but is some way above the midpoint of the 2–3 per cent target range. Inflation in the June quarter was broadly in line with the May Statement forecast, with headline inflation at 3.8 per cent over the year and trimmed mean inflation at 3.9 per cent. But the latest data also demonstrate that inflation is proving persistent and the quarterly underlying inflation rate has fallen very little over the past year.

Inflation is expected to take slightly longer to reach the target than was thought at the time of the May forecasts. Underlying inflation is forecast to return to the target range of 2–3 per cent in late 2025 and approach the midpoint in 2026. This is a slightly slower return to target than forecast in May and is due to greater inflationary pressures in the economy. In part, this owes to a stronger outlook for domestic demand, led by higher public demand and a recovery in household consumption as real disposable incomes and household wealth rise. But it also reflects the assessment that the economy’s capacity to meet this demand is less than previously thought.

The cash rate remains unchanged to support inflation returning to target.

The outlook remains highly uncertain. Ongoing strength in the labour market, persistent inflation and still-high growth of both labour and non-labour costs suggest there are upside risks to inflation. At the same time, there is a risk that household consumption and economic activity pick up more slowly than expected. The unemployment rate is rising gradually, many households and businesses are under pressure and the lagged effects of monetary policy are uncertain. Conditions in the labour market could deteriorate by more than expected.

At its August 2024 meeting, the Reserve Bank Board decided to hold the cash rate. Inflation in underlying terms remains too high and it will be some time yet before inflation is sustainably in the target range. Data have reinforced the need to remain vigilant to upside risks to inflation. Returning inflation to target within a reasonable timeframe remains the Board’s highest priority.

Policy will need to be sufficiently restrictive until the Board is confident that inflation is moving sustainably towards the target range. The Board will rely upon the data and the evolving assessment of risks to guide its decisions and remains concerned about the upside risks to inflation.

What’s been going on in the economy?

Growth among Australia’s major trading partners has been moderate, and progress on lowering inflation has been mixed.

A gradual recovery of economic growth is underway in many of Australia’s major trading partners but has been weaker than expected in China. Temporary disruptions and ongoing weakness in the property sector have dampened consumption and broader economic activity in China and weighed on commodity prices. While growth also appears to be slowing in the United States, a gradual recovery is underway in most other advanced economies, although generally below estimates of potential growth.

Progress on bringing inflation back to targets has been mixed. Disinflation has resumed in the United States in recent months but has stalled in some other economies, particularly in Europe. In some economies, including Canada and Sweden, inflation has returned close to target. Unemployment rates abroad are generally increasing as labour markets move into better balance. However, wages growth has been high in most advanced economies, in part reflecting some catch-up following earlier high inflation.

A number of advanced economy central banks have lowered their policy rates and more are expected to do so over coming months. Market participants expect the US Federal Reserve to ease its policy rate a number of times in the coming months. Yields on government bonds have fallen as the policy rate and inflation expectations have declined. In China, authorities have eased monetary policy amid slowing economic activity, an uncertain economic outlook and softer credit demand. Government bond yields in China have continued to decline and the currency has depreciated against the US dollar. Globally, financial markets have been volatile of late.

Financial conditions in Australia remain restrictive but less so than previously assessed.

The current level of the cash rate is assessed to be restrictive. Ahead of the August Board meeting, financial market participants expected the cash rate to remain at current levels, and for monetary policy to begin easing around the turn of the year and to continue gradually through 2025.

Overall financial conditions are also assessed to be restrictive, but a little less so than at the time of the May Statement. In part, this reflects the decline in policy rate expectations in Australia and abroad, and the associated declines in bond yields. Higher housing prices are supporting household wealth and housing credit growth has picked up, suggesting that households have become more willing to borrow. Recent volatility in financial markets has the potential to affect financial conditions including through its impact on the Australian dollar, which has already depreciated of late.

In Australia, domestic demand was more resilient in early 2024 than previously thought. Household consumption and public consumption have both proved stronger than expected at the time of the May forecasts. The upside surprise to domestic demand has occurred alongside robust growth in imports, while exports were slightly softer than expected. As a result of the drag from net trade, Australia’s GDP grew by less than expected in the March quarter.

The housing market remains tight, resulting in housing prices rising more briskly than expected in recent months and further strong growth in advertised rents. This reflects the lack of new housing supply and strong demand. Dwelling investment in early 2024 was weaker than anticipated as high construction costs made some projects unfeasible and labour shortages remain for certain trades.

Disinflation has slowed and, despite gradual easing, the labour market remains tight.

Underlying inflation eased slightly in the June quarter but remained high. Underlying inflation, as measured by trimmed mean inflation, declined a little to 0.8 per cent in the quarter and to 3.9 per cent in year-ended terms. Headline inflation increased in year-ended terms to 3.8 per cent. These outcomes are broadly as expected in the May Statement and show that the pace of disinflation has slowed.

The slow progress on disinflation over the past year suggests that demand continues to exceed the capacity of the economy to supply goods and services, and by a little more so than previously thought. This is consistent with firms continuing to report that they operate at relatively high levels of capacity utilisation and with input cost inflation remaining above longer run averages.

Labour market conditions continue to ease gradually. The unemployment rate moved up in June as expected. Even so, employment and average hours worked have surprised on the upside, vacancies remain high and some businesses continue to report labour shortages as a constraint on output. Wages growth remains high, particularly given still weak productivity growth, but business liaison suggests that growth in wages is expected to moderate over the year ahead.

How do we see the economy developing?

Growth in Australia’s major trading partners is expected to continue to be moderate and inflation abroad is expected to ease further.

There has been little change in the overall outlook for growth among our major trading partners, although the near-term outlook for China has been revised lower. Inflation is expected to continue to ease in advanced economies, although persistent services inflation and a sharp rise in shipping costs pose upside risks.

The recovery in domestic economic activity is expected to be stronger than forecast in May, alongside a gradual adjustment in the labour market.

In Australia, the outlook for GDP growth has been upgraded for 2025. Public demand is forecast to be stronger than previously expected, reflecting recent public spending announcements by federal and state and territory governments. The level of consumption has been revised higher and growth is expected to pick up, supported by a rebound in real household disposable incomes and the rise in household wealth. Stronger growth in imports and weaker growth in dwelling investment is expected to provide some offset.

The labour market is expected to continue to ease this year, but to remain somewhat tight over much of the forecast period. The unemployment rate is forecast to continue to increase gradually, consistent with the softening in the leading indicators of labour demand. The expected recovery in GDP growth will support conditions in the labour market. Average hours worked are likely to decline and there will be fewer vacancies per job seeker, but employment is forecast to continue to grow.

Greater underlying inflationary pressures are expected to delay the return of inflation to target.

It will take a little longer for inflation to return to the midpoint of the target range than thought at the time of the May Statement. Underlying inflation is expected to be inside the target range of 2–3 per cent in late 2025 and approach the midpoint of the band in 2026. The upward revisions to underlying inflation reflect the stronger outlook for activity and the reassessment of capacity. Inflation is expected to ease gradually as excess demand in the economy declines. Persistence in some components of inflation is expected to limit the pace of disinflation.

Headline inflation is expected to moderate temporarily in the near term, owing primarily to one-off measures including those providing cost-of-living support to households. However, headline inflation is then expected to increase as energy rebates end (as currently legislated), before moving in line with underlying inflation once these temporary effects have passed.

Key risks to the outlook

The risks to the domestic outlook are assessed to be broadly balanced. Inflation may take longer to reach the inflation target if the labour market is tighter than currently assessed or if the recovery of domestic activity is stronger than anticipated, creating more inflationary pressure in the economy. There is also a risk that conditions in the labour market could deteriorate faster – for example, if household consumption does not pick up as expected, which would dampen input costs and inflationary pressure.

It is important to bring down inflation and keep long-term inflation expectations anchored at the inflation target. High inflation lowers living standards by eroding real incomes, and it is particularly challenging for those with lower incomes. The longer it takes for inflation to return to target, the greater the cost-of-living pressures on households and the greater the risk that inflation and wage expectations drift higher. History shows that, should this occur, it would require more monetary policy tightening and a costly period of higher unemployment to stabilise inflation expectations and return inflation to target. At the same time, a sustained period below full employment can have long-lasting effects on those who lose their jobs or are unable to find work.

What did the Board decide?

The Board decided to hold the cash rate to support inflation returning to target. Today’s decision balances the dual objectives of monetary policy. It balances the risk of further setbacks to the time it takes to return inflation to target with risk that there could be a more significant easing in labour market conditions than forecast. Data have reinforced the need to remain vigilant to upside risks to inflation and the Board is not ruling anything in or out. Policy will need to be sufficiently restrictive until the Board is confident that inflation is moving sustainably towards the target range. Returning inflation to target within a reasonable timeframe remains the Board’s highest priority.