Delicate touchdown?

Gross domestic product (GDP) growth came in at around 1.5 per cent over the first half of 2023, inflation has moderated and the labour market remains solid with only a little slack creeping in. The Reserve Bank of Australia has left rates unchanged for the past four meetings.

"The combination of falling real incomes and elevated discretionary household consumption over 2022 has produced a sharp slowing in consumer spending over more recent quarters.”

The economy is expected to grow by 1.1 per cent over the year to the December quarter. This forecast implies a step down in the rate of growth from that seen over the first half of the year.

Beyond 2023, ANZ Research sees a modest pick-up, supported by rising real household incomes as inflation moderates, with the bulk of the direct transmission of higher interest rates to the household sector having passed. Come the middle of 2024, tax cuts will further support household incomes and consumption.

For now, the impact of inflation, higher interest rates and fiscal drag on the household sector is very apparent. These factors are taking a significant bite out of the robust increases in nominal labour income on account of the strong trend in the labour market.

Sharp slowing

The combination of falling real incomes and elevated discretionary household consumption over 2022 has produced a sharp slowing in consumer spending over more recent quarters.

A decline in discretionary spending is dominating that weakness in consumption, which reflects both the recent weakness in real household incomes and spending returning to more normal levels.

Consumption growth will likely remain weak over the rest of 2023, before a mild pick-up in 2024 driven by rising real incomes. As a result, ANZ Research expects the second half of 2023 to mark the softest point for activity.

Strong population growth continues to support headline growth across the economy. The estimates contained in the second-quarter 2023 national accounts had population growth at 2.4 per cent during 2023, while those in the monthly labour force survey have the civilian population aged over 15-years rising 2.8 per cent in the year to August.

On a per-capita basis, ANZ Research sees GDP falling quarter-on-quarter until the second half of 2024.

While housing prices have recently risen and are likely to continue to rise given strong rental and buying demand for dwellings, construction activity has turned down modestly. Recent trends in building approvals suggest further falls are likely, although significant backlogs in the construction sector should limit the pace of any decline.

In contrast to the weakness in the household sector, the business sector remains in good health. Survey-based measures of business conditions continue to run at above average levels, while measures of business confidence and forward orders have recovered over recent months to be around long-run average levels.

Private business investment has also been a solid source of growth over the past few quarters and has somewhat offset the weakness in household consumption. The Australia Bureau of Statistics’ forward-looking capex survey also points to moderate growth in real business investment over 2023-2024.

With capacity use remaining high and balance sheets in good shape, underlying fundamentals for growth in investment remain positive, despite the uncertain demand environment.

Unemployment nudges higher

The unemployment rate has nudged marginally higher, but at just 3.7 per cent remains very low. Strong population growth is tending to lift the headline employment aggregates, although some slack is starting to creep in. These signs of slack include an easing in hours worked, the unemployment rate having lifted off its low and a steady drift higher in the underemployment rate.

The pace of employment growth is likely to soften, broadly consistent with the slowing already seen in GDP growth. ANZ Research does not, however, expect employment to fall in any sustained fashion. Rather, an increase in unemployment will more reflect jobs growth being insufficient to absorb new entrants into the labour market.

Wages growth has so far tended to surprise a little to the downside. However, ANZ Research expects it to pick up in coming quarters as minimum wage decisions flow through, public sector wages lift and recently concluded enterprise agreements in the private sector filter into official wages measures.

These factors should offset any downward pressure on wages growth from the mild easing in the labour market. Inflation has moderated over the course of 2023. But almost all the moderation is in tradables inflation, with domestically sourced inflation remaining stubborn.

Whether non-tradables inflation ultimately remains sticky will come down in large part to the combination of wages growth and productivity.

As the RBA has noted, while the current pace of wages growth is likely to be consistent with the 2 per cent to 3 per cent inflation target band, that will require a lift in productivity. To date the underlying trend in productivity has been obscured by the impact of, and recovery from, the pandemic.

From the September quarter 2023 onward, ANZ Research expects the underlying trend in productivity will become clearer. There is some risk productivity growth settles closer to 0.5 per cent than 1 per cent. As a result, inflation could remain stuck above the top of the 2 per cent to 3 per cent target band. That, however, is an issue for 2024.

For now, ANZ Research sees the RBA on an extended pause before a modest easing cycle starting late next year. As for risks around that view, additional rate hikes, either around the end of this year or early next, are much more likely than an early easing cycle.

That skew on risks reflects the possibility rising real incomes lift consumer spending, inflation surprises to the upside or the labour market does not ease as much as expected. The most plausible downside risk would appear to be a negative global shock.

Adam Boyton is Head of Australian Economics at ANZ Research

A version of this article was originally published in ANZ Insights