Economic data released in February showed most major economies showing slow growth bordering recession. A notable exception is the United States where most economic readings point to improving growth and off a firm base in the second half of 2023. The slow growth economies of Europe, Japan as well as Australia continue to share one key theme in common with the faster growing US, still tight labour market conditions generating relatively high wage growth and continuing concerns for central banks about how soon or whether they can see inflation returning to the targets they have set. In the softer growing economies, China is an odd-man-out, experiencing difficult-to-reverse weak demand, excess capacity and deflationary pressure.
For the most part, central banks in February continued to push back against market expectations that official interest rates will be cut several times later this year. In the US, while with a high 5.50% funds rate, the Fed is unlikely to need to hike rates even higher, the strength of recent economic reports makes it unlikely the Fed can cut the funds rate until much weaker economic conditions show and at present the opposite of weak is showing in housing investment; consumer, business and government spending; and the labour market.
In Europe, including the UK, economic reports in February show no growth in the euro-area and recession in the UK, but with wage growth running at 5% y-o-y and higher that means that the reduction in annual inflation since mid-2023 is likely to stall and above the targets of the European Central Bank and the Bank of England. The ECB and the Bank of England would like to start cutting their official rates to address weakening demand (4.00% for the ECB’s deposit rate and 5.25% for the Bank of England’s base rate) but are stymied by sticky inflation prospects.
In Australia, strong population growth driven by high immigration has kept the economy out of recession so far. Q4 GDP will be released early in March and is likely to show around 0.3% q-o-q growth reducing annual growth to around 1.5% y-o-y from 2.1% y-o-y in Q3 2023. However, December and January reports released in February show mostly softer growth.
On the housing front, December home building approvals fell by 9.5% m-o-m and the value of new home loans fell 5.6% m-o-m albeit after strong growth in November and December. Demand for housing is strong reflected in mostly still rising house prices, but new housing supply and home building activity is weak, beset by a range of high costs and constraints for developers from high borrowing costs to difficulties and high costs obtaining labour and supplies to worsening and lengthening building approval processes.
Housing investment is likely to continue to show negative change in the approaching Q4 GDP report detracting from GDP growth. Federal and State Government initiatives aimed at lifting construction of social housing may start to turn housing investment positive, towards end-2024 and in 2025.
Retail sales fell 2.7% m-o-m in December, more than wiping out the 1.6% lift in November fostered by the growing number of special sales in that month. Consumer spending is weak and under pressure from falling real household disposable income.
Until Q4 2023, real wage growth was negative. The income tax burden was higher in 2023-24 after the end of the low- and middle-income tax rebate on July 1st, 2023. Net interest payable by households rose sharply through 2023 on the back of RBA rate hikes in 2022 and 2023 contributing to negative growth in real household disposable income. Real household consumption spending is down to near flat quarterly change in Q4 2023. Some revival in real household disposable income and spending is likely in the second half of this year assisted by real wage growth, income tax cuts from July 1st and stable net interest payment burden. However, in the first half of 2024, household consumption spending could be weak enough to drive down the economy close to recession.
The labour market is showing some softer signs. Employment rose by only 500 in January after falling by 62,700 in December. The unemployment rate lifted to a two-year high of 4.1% in January although that is still a comparatively low unemployment rate by historical comparison. If the labour market weakens further, it will add to the warning signs of a possible recession in Australia and may lean the RBA towards more actively heralding a rate cut down the track.
Standing in the way of the RBA heralding a rate cut is annual wage growth running above 4% y-o-y in conjunction with very weak labour productivity, -2.1% y-o-y in Q3 2023, hopefully improving to -1.0% or better in the approaching Q4 GDP report.
Sub-zero annual labour productivity growth combined with above 4% wage growth will underpin inflation nearer to 4% or more. While recent inflation readings have shown annual inflation coming down (4.1% y-o-y in Q4 and 3.4% y-o-y in December) under pressure from softer growth in demand in the economy getting inflation down consistently within the RBA’s 2-3% target will require annual wage growth to recede to 3.5% y-o-y and productivity to lift to more than +1% y-o-y.
Signs of weakening demand and a softer labour market may help the RBA to be more confident that inflation can come down to its target in a reasonable time frame. But with factors on the near horizon that are likely to boost real household disposable income and spending in the second half of 2024, the RBA will need to see evidence that annual wage growth has peaked and is starting to recede combined with some recovery in labour productivity before it can consider cutting the cash rate.
We see these wage/ productivity preconditions for a rate cut taking at least 6 months to show placing November or December the first meeting opportunities for the RBA to start cutting rates, although that timing could easily be pushed out further.