Statement on Monetary Policy – May 20242. Economic Conditions

2.1 Global economic conditions

Economic growth in advanced economies generally remains subdued, but some recent data have been a bit more positive.

Growth in economic activity remains weak in Europe, Canada and New Zealand, but is starting to pick up a little in these economies (Graph 2.1). In Canada and New Zealand, subdued output growth has occurred despite strong population growth, and GDP per capita has declined substantially since late 2022. In many advanced economies, growth in activity is below central bank estimates of potential growth and the level of demand is now likely to be below the level of potential output (see Chapter 4: In Depth – Potential Output for an explanation of these concepts). While quarterly GDP growth has generally started to pick up a little from its troughs in these economies, it remains below potential. As such, the degree of excess supply is still expected to increase further this year, which should place further downward pressure on inflation.

By contrast, the US economy continues to experience robust growth in domestic demand, even as GDP growth has slowed from its strong pace last year. Official estimates suggest that the level of demand and supply potential in the US economy are balanced. Updated population estimates suggest recent population growth has been higher than previously thought, and this has added to both supply and demand in the economy. Growth has also picked up in some high-income economies in east Asia (e.g. South Korea), supported by stronger technology exports from the region.

The soft economic activity in most advanced economies has been driven by weak domestic demand, but some forward-looking indicators have improved. Household consumption growth has typically been sluggish, with partial indicators such as retail sales generally remaining soft; consumer confidence also remains well below its long-run average. Weakness in consumption growth has occurred despite positive growth in real household disposable incomes over the past year or so, supported by tight labour markets and declining inflation (Graph 2.2). The United States remains a key exception, where consumption growth has been more resilient alongside ongoing strong labour market and inflation data. On the other hand, business investment in some advanced economies has been relatively resilient over the past year or so, but growth has moderated in recent quarters. Looking further ahead, surveyed measures of business investment intentions are beginning to pick up again. Surveyed business conditions have also improved in a number of advanced economies in recent months, with growing signs of an expansion in services sector activity and less weakness in the manufacturing sector.

The US labour market has surprised with recent strength, but most other advanced economies have seen labour market conditions ease gradually.

Labour markets remain tight, notwithstanding further gradual easing in most advanced economies. Much of the easing in labour demand has been seen in declines in job vacancy rates (from exceptionally high levels), with comparatively small increases in unemployment rates (Graph 2.3). Accordingly, unemployment rates are generally only a little above their recent troughs. Canada is a notable exception, where the unemployment rate has increased more substantially, as employment growth has not kept pace with gains in the labour supply (including from strong population growth). By contrast, the US unemployment rate has been little changed despite strong population growth, reflecting strong labour demand. Some modest further increases in unemployment rates are expected for most advanced economies, as labour demand continues to ease and vacancy rates reach more normal levels.

Wages growth is generally easing but remains elevated. Unit labour costs have also been growing very strongly; however, early signs of a pick-up in labour productivity in some economies has started to provide some offset to this. The pick-up in productivity growth has been especially pronounced in the United States since mid-2023 and as a result unit labour costs have not increased since then.

Inflation remains above target in most advanced economies and the decline in inflation has paused in some.

Although inflation has continued to ease in year-ended terms, progress has been uneven, and more timely measures of core inflation have increased in some economies (Graph 2.4; Graph 2.5). This has been most notable in the United States (e.g. in three- and six-month-ended annualised terms) but has also been evident in the euro area. By contrast, Canadian inflation has eased more rapidly than expected in early 2024, consistent with a marked easing in labour market conditions. After decades of below-target inflation, headline and core inflation in Japan has been above 2 per cent since early 2023, with wages growth also beginning to pick up. In response, the Bank of Japan raised its policy rate from negative levels in March for the first time in 17 years (see Chapter 1: Financial Conditions).

Services inflation has generally been more resilient recently than it was late last year. In most economies, both housing and non-housing services inflation remains above pre-pandemic averages. Housing inflation remains especially high in economies where the supply of new dwellings has been slow to adjust to strong demand (such as in Canada) (Graph 2.5). Excluding housing services, core services inflation has generally remained elevated, and, in the United States, this measure has lifted again, consistent with resilient services sector activity and strong labour markets.

The easing in core goods inflation appears to have largely run its course in some economies, but there are risks in both directions. Oil prices have increased significantly since the start of the year due to geopolitical tensions, and further escalation in the Middle East poses renewed upside risk to oil and goods inflation (see Chapter 3: Outlook) (Graph 2.6). Acting in the opposite direction, there is still a little scope for further downward pressure on goods inflation if earlier disruptions to some global shipping routes continue to resolve, particularly through the Panama Canal.

Economic activity in China has strengthened at the start of 2024, but the property sector remains a significant drag on growth.

In China, GDP growth increased in the March quarter, driven by a rebound in household consumption – in part reflecting strong tourism spending during the Lunar New Year holiday – and stronger external demand (Graph 2.7). The strengthening in external demand was driven by stronger exports to east Asia and coincides with a modest improvement in global manufacturing conditions. If the March quarter pace of growth was maintained throughout the year, GDP growth would be on track to exceed the Chinese authorities’ 2024 growth target of ‘around 5 per cent’.

The real estate sector is continuing to drag on growth; new housing starts and sales remain weak, and declining housing prices are weighing on consumer confidence. Manufacturing and infrastructure investment growth continue to outweigh the drag from real estate investment, partly through policy support. This support is ongoing, with authorities budgeting for an increase in the consolidated fiscal deficit from 7 per cent of GDP last year to over 8 per cent in 2024. (The consolidated fiscal deficit is a broader measure than the published headline deficit as it includes the budget balance of government-managed funds and abstracts from balancing items.)

Iron ore and coking coal prices have partially recovered from sharp declines earlier in the year, alongside improved Chinese economic data, and base metal prices have also risen.

Iron ore prices declined sharply at the beginning of the year, alongside a steady build-up of iron ore inventories in China (Graph 2.8). This build-up occurred as iron ore imports remained strong despite a delayed recovery in steel demand following the Lunar New Year holiday. These factors have now started to unwind and, alongside improved Chinese economic data, have contributed to a partial recovery in iron ore prices over the past month. Base metals prices have also picked up in recent months amid early signs of a pick-up in demand, although supply disruptions have also contributed.

2.2 Domestic economic activity

Growth in the Australian economy remains subdued.

Growth has slowed considerably over 2023 – driven by weak growth in the household sector. This is helping to bring the level of demand back into balance with supply. However, our assessment is that demand remained above the economy’s ability to supply goods and services without putting upward pressure on inflation.

Economic outcomes have been mixed across different sectors of the economy (Graph 2.9). Household consumption growth has been weak over the past year, as high inflation, strong growth in tax payments and higher interest rates have resulted in a decline in real household disposable income. Dwelling investment has also declined – reflecting low approvals, affordability concerns and capacity constraints. This has been partially offset by strength in business and public investment, as well as spending from tourists and international students, although quarterly growth across these components slowed in late 2023. The recent data, including partial indicators for the March quarter, suggest that economic growth since the start of the year has been a little softer than was expected at the time of the February Statement.

Household consumption growth remains weak amid high inflation, tax payments growing faster than incomes and higher interest rates.

Real disposable incomes have declined sharply over the past 18 months (Graph 2.10). Strong growth in nominal incomes has been offset by high inflation, strong growth in tax payments and higher interest rates. Real incomes are beginning to stabilise following the decline in inflation and slowing in the pace of interest rate increases. Further declines in inflation and the implementation of the Stage 3 tax cuts are expected to result in real incomes growing strongly in the second half of 2024.

Households continue to curb their spending, particularly for discretionary items. Consumption growth remained weak in the December quarter and declined further on a per capita basis; the recent declines have been driven by a decline in spending on discretionary goods and services. Retail sales, spending indices based on transactional data, and information from the RBA’s liaison program suggest that these weak outcomes have continued into the March quarter of 2024.

Households have been saving more than was expected three months ago. Household saving ratios were revised higher over most of 2023 and were much stronger than expected for the December quarter, reflecting downward revisions to consumption growth and stronger-than-expected growth in household incomes. Higher interest rates are providing an incentive for some households to save more, to a greater extent than was expected three months ago. Consistent with this, extra payments into mortgage offset and redraw accounts have increased since mid-2023 to be slightly above their pre-pandemic average (see Chapter 1: Financial Conditions).

Growth in total consumer spending in Australia has slowed further, driven by a slowdown in the growth in international student numbers. Total consumer spending faced by Australian businesses includes consumption by residents in Australia as well as spending by international students and tourists. Growth in international student numbers is expected to slow further this year, with tighter visa processing standards decreasing the proportion of student visa applications being granted. Demand for international education remains high though, with student visa lodgements still elevated amid a tightening of entry requirements in competing markets, particularly Canada and the United Kingdom.

Growth in business investment has been strong recently but is expected to slow.

Business investment has grown strongly over the past 18 months. Following broad-based strength in early 2023, growth in non-mining investment moderated somewhat in the second half of last year (Graph 2.11). Non-residential construction continued to grow strongly, supported by large renewable infrastructure projects, data centres, warehouses and continued progress on the pipeline of yet-to-be-done construction work. Firms also continued to invest in software alongside projects for automation and digitisation. Machinery and equipment investment has declined in recent quarters but remains at an elevated level, particularly for the construction and logistics industries. Firms in the RBA’s liaison program have continued to report that investment has been supported by a backlog of orders and further easing in supply chain disruptions.

Firms expect the pace of investment growth to slow in the year ahead. Firms’ expectations for non-mining investment have been revised upwards for 2023/24, partly reflecting planned spending on heavy construction machinery related to large infrastructure projects. Early estimates of nominal investment intentions for 2024/25 show that firms intend to increase non-residential construction investment, supported by a pipeline of infrastructure and renewable energy projects. In other sectors, growth in investment is expected to slow from current elevated rates. Investment intentions reported by firms in the RBA’s liaison program have declined to around their longer run average and the value of private non-residential building approvals have continued to trend lower in recent months to be around their pre-pandemic averages. This is consistent with the recent easing in surveyed measures of business conditions; some firms have cited higher costs and uncertainty around the outlook as weighing on their investment plans.

Housing supply continues to fall short of underlying demand.

The supply of new housing remains low because of capacity constraints in the latter stages of construction and weak demand for new building. Dwelling investment declined sharply in the December quarter after remaining little changed over the previous four quarters. RBA liaison contacts note that elevated construction activity in the private non-residential and public sectors is exacerbating capacity constraints, particularly for labour in the higher density construction sector that requires similar skills. Higher interest rates, elevated construction costs and construction delays have all weighed on buyer sentiment and dampened demand for new building, particularly for high-density construction where some developers in the RBA’s liaison program have deemed new projects unviable in the current environment (Graph 2.12).

Low average household size and strong population growth have contributed to strong growth in the demand for housing space in recent years. A shift in preferences during the pandemic towards more residential space led to a lower average household size (Graph 2.13). Average household size has been little changed since mid-2023 and remains well below pre-pandemic levels in capital cities. The faster pace of price growth for houses than for units since the pandemic could also indicate a shift in preferences, with this price differential widening further in recent months.

Advertised rents continue to grow strongly but national housing price growth has slowed. Capital city advertised rents have grown by nearly 10 per cent over the past year, with growth broadly based across cities; growth in actual rents paid by new tenants has been a little higher than this over the past year but growth has now slowed to be closer to that of advertised rents. The pace of advertised rents growth has picked up in regional areas but remains below 2021 peaks. Housing prices grew around 9 per cent over the past year but quarterly annualised growth (seasonally adjusted) slowed to 3.5 per cent in March, with the slowing driven by the more expensive capital cities. Housing price growth has been stronger for lower value properties, which may indicate that buyers have been competing for more affordable properties.

2.3 Labour market and wages

The labour market has continued to ease only gradually and remains tight.

The easing in labour market conditions over recent months has been more gradual than had been anticipated in the February Statement. The unemployment rate was 3.8 per cent in March, slightly above its 50-year low of 3.5 per cent in late 2022, and remains below estimates of the rate consistent with full employment (see section 2.4 Assessment of spare capacity). The participation rate remains near its record high owing to increased participation by females and older workers. As growth in employment has kept pace with working-age population growth, the employment-to-population ratio has been stable near its historically high level.

Much of the easing in labour market conditions over the past year has occurred through declining average hours worked and fewer job vacancies. Average hours worked have declined substantially over the past year, reversing the increase over 2022 (Graph 2.14). This has been driven by a decline in the average hours worked by full-time employed persons and an increasing share of employment growth occurring in part-time employment. The hours-based underutilisation rate has increased by more than the heads-based unemployment rate since late 2022, consistent with hours worked being a key margin of adjustment to the easing in labour demand.

Firms have reduced labour demand more so by hiring fewer additional workers rather than laying off staff. Job advertisements and vacancies have continued to decline but remain above their pre-pandemic levels. Firms in the RBA’s liaison program still expect to increase headcount in the year ahead, but at a slower pace than at the 2022 peak. Information from liaison and business surveys suggest labour availability has improved over the past year.

Wages growth appears to be around its peak for the current cycle, with some indications it will moderate over the year ahead.

Growth in the Wage Price Index (WPI) increased a little further in year-ended terms in the December quarter to be 4.2 per cent and appears to be around its peak for the current cycle (Graph 2.15). The most recent increase in WPI growth was partly driven by stronger-than-expected public sector wages growth, reflecting a larger proportion of jobs receiving a wage change than usual, particularly in New South Wales and Queensland. The outcome was also boosted by some large specific outcomes, including significant pay increases for NSW teachers. By contrast, private sector wages growth has begun to show signs of moderation following the easing in the labour market.

Wages growth appears to have peaked for workers on individual arrangements, whose wages are most responsive to current labour market conditions. By contrast, wages growth has continued to strengthen for enterprise bargaining agreements where economic conditions take time to flow through (Graph 2.16).

Market economists and firms in the RBA’s liaison program expect wages growth to decline a little, with average wages growth expectations around 3½ per cent for the year ahead. Firms that expect a decline in wages growth have noted expectations for lower inflation, smaller award rate increases and a softening labour market as reasons for this.

Unit labour cost growth remains elevated, but it has moderated recently and is expected to slow further.

Year-ended unit labour cost growth appears to have peaked but remains strong, at around 7 per cent, reflecting robust wages growth and weak productivity outcomes (Graph 2.17). If prolonged, this would represent an upside risk to the inflation outlook and could delay inflation returning to target. Unit labour cost growth has moderated slightly in recent quarters, broadly as expected, reflecting the recent pick-up in labour productivity growth. A pick-up in labour productivity growth was expected, in part because the capital-to-labour ratio was forecast to recover in response to strong business investment.

2.4 Assessment of spare capacity

The labour market is assessed to still be tighter than full employment and is easing only gradually.

A broad range of indicators have eased from their very tight levels in late 2022, though several indicators remain tighter than their historical norms (Graph 2.18). The easing in some measures, including the unemployment rate, has been quite modest, particularly over recent months. Easing has been more apparent in forward-looking indicators such as job advertisements and employment intentions, which are now well within the range of their historical outcomes.

Model-based estimates suggest that the labour market has remained tighter than full employment, consistent with elevated domestic inflationary pressures and robust wages growth. 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 ‘gaps’ (Graph 2.19). These gaps have narrowed over the past year, but by slightly less than expected since the February Statement, suggesting the labour market is only gradually moving towards full employment. There is substantial uncertainty surrounding estimates of full employment, particularly with how they evolved during and since the pandemic.

Aggregate demand remained above the level of potential output, although the gap narrowed quickly.

Our overall assessment is that aggregate demand for goods and services remained above the supply potential of the economy in the December quarter of 2023. This assessment is informed by a range of indicators, including model-based estimates of the output gap (the difference between actual and potential output) and survey measures of capacity utilisation, alongside inflation outcomes (see Chapter 4: In Depth – Potential Output for more information on how this assessment is made). Since the February Statement, survey measures of capacity utilisation have continued to ease, suggesting the economy is moving closer to balance than three months ago (Graph 2.20).

A range of model-based estimates suggest the output gap was positive, but closing (Graph 2.21). The level of output remained above estimates of potential output in the December quarter of 2023 – both labour and capital resources were being utilised beyond the maximum intensity that can be sustained without creating inflationary pressures. Although the output gap was estimated to be positive across the suite of models, subdued growth in output relative to potential is returning the economy to a more balanced state. This has occurred as demand in the economy has continued to slow in response to high interest rates and high inflation.

However, there is significant uncertainty around when the output gap will close. An important source of uncertainty is whether productivity growth over recent years and in the period ahead results in an overall persistent adverse effect on the level of productivity, and therefore potential output. The continued easing of capacity pressures on economic activity is consistent with the easing in labour market conditions, with the decline in labour demand so far being absorbed more by average hours and vacancies rather than the heads-based unemployment gap.

2.5 Inflation

Inflation eased further in the March quarter in year-ended terms but remains high and the pace of disinflation has slowed.

The easing in inflation over the year to March was mainly driven by a further easing in goods and utilities inflation, while other services inflation remains high. The CPI increased by 0.9 per cent in the March quarter to be 3.6 per cent higher over the year, down from 4.1 per cent in the December quarter (Graph 2.22). Measures of underlying inflation (which are designed to better capture the trend in inflation) also eased in year-ended terms; trimmed mean inflation was 1 per cent in the quarter and 4 per cent over the year (Graph 2.23). These outcomes were stronger than expected at the time of the February Statement. Despite seeing further progress on disinflation in year-ended terms, the pace of disinflation has slowed in recent quarters. This slowing, together with inflation being still too high, is consistent with the assessment that the labour market has remained tight, that output has been above potential, and domestic cost growth has been high.

Services inflation has passed its peak, but remains elevated.

Market services inflation remains high and broadly based across categories (Graph 2.24). Inflation in the March quarter was stronger than expected three months ago and remains above its historical average for a range of household services and insurance. This reflects continued pressure from both labour and domestic non-labour input costs such as insurance, legal, accounting and other administrative services. Unit labour costs represent a particularly large share of input costs for many services firms and continue to grow strongly. Retail and office rents are some of the few non-labour costs that are not adding materially to inflationary pressures. More recently, easing demand growth for some discretionary services, such as meals out and takeaway food, is starting to place downward pressure on inflation.

Rent inflation remains high, and this is expected to persist. Rent inflation – for the stock of rents captured in the CPI (which excludes regional areas) – was 2.1 per cent in the quarter and 7.8 per cent over the year (Graph 2.25). The pick-up in quarterly inflation was expected after the earlier increase to Commonwealth Rent Assistance lowered rent inflation in the December quarter. Tight rental market conditions across the capital cities will likely contribute to ongoing high advertised rent growth, which will in turn keep CPI rents inflation elevated.

Inflation for goods and services with administered prices eased in year-ended terms. In the CPI basket, ‘administered prices’ are (at least partly) regulated or relate to items for which the public sector is a significant provider. Higher inflation for education over the year was offset by easing health and utilities inflation, particularly for electricity. Electricity contributed around 0.3 percentage points less to year-ended headline inflation in the March quarter than otherwise due to the government rebates, though these rebates are legislated to unwind over coming quarters.

Goods price inflation continued to ease, albeit at a slowing pace.

Quarterly goods inflation was higher than expected and is beginning to stabilise, though easing continued in year-ended terms. This is consistent with the earlier easing in price inflation of imported consumption goods having largely flowed through to domestic prices. Most firms in the RBA’s liaison program report that supply chains are largely operating as normal after several years of disruption. Upward pressure on shipping costs due to the Red Sea conflict has been less significant than anticipated, and disruptions to the Panama Canal have begun to ease. Nonetheless, domestic labour and non-labour costs (including electricity, insurance, and warehousing and logistics rents) continue to place some upward pressure on goods prices.

Consumer durables inflation was around zero over the year to March (Graph 2.26). This is consistent with information from the RBA’s liaison program suggesting firms are intensifying cost discipline with a variety of approaches (e.g. re-evaluating expenses and pushing back on supplier cost increases) to moderate cost and price growth. Groceries inflation continued to ease sharply and in a broad-based manner.

New dwelling cost inflation has stabilised in recent quarters, above its average level over recent decades. Labour costs and some energy-intensive materials are driving ongoing cost growth, partly driven by the large pipeline of work and ongoing capacity constraints in construction.

Inflation expectations remain consistent with achieving the inflation target over time.

Survey and financial market measures of short-term expectations have declined notably from their mid-2022 peaks, consistent with recent declines in actual inflation, though some expectations measures continue to suggest that inflation over the next year is expected to remain above the RBA’s inflation target. Measures of medium- and long-term expectations have increased over the past year but overall remain consistent with the inflation target (Graph 2.27).