All going well most major OECD economies, including Australia, should experience easing labour market conditions in 2024 helping to push down inflation and to pave the way for central banks to start cutting official interest rates. Some countries will experience recession in the process including several in the European Union, the most notable being Germany. In Europe, outside the EU, the United Kingdom and Sweden are also recession candidates. At this stage, the US and Australia may avoid recession and experience a soft landing a barely credible outcome if it occurs given the large increases in interest rates over the past two years.
In the US financial markets have celebrated through November and the first half of December the possibility that the Federal Reserve will pivot in 2024 and move into aggressive rate cutting mode taking the Funds rate down from 5.50% to near 3.50% over the next year. The Federal Reserve pushed back against the market’s view of several rate cuts in 2024 until its policy meeting last week when it conceded that rates could be cut next year. The interest rate dot point forecasts of the senior Fed officials were cut at that meeting with the average 1-year rate forecast cut to 4.6% from 5.1% three months earlier. The two-year forecast was also cut to 3.6% from 3.9%.
The Fed was saying in its last policy meeting of 2023 that it is likely that moderating US economic growth, a less tight labour market and slowing inflation will allow it to start cutting rates, but not as early or fast as the market is expecting. The message was reinforced late last week by New York Fed President John Williams who indicated market expectations of the Fed starting to cut rates from March were too early and that the rate cutting program was likely to be a slower and later process than the market was factoring in.
Essentially, the US economy is still growing relatively strongly (5.2% annualised GDP growth in Q3 and tracking 2%+ in Q4), with a low unemployment rate (down to 3.7% in November from 3.9% in October), strong employment growth (nonfarm payrolls up 199,000 in November) and wage growth sticky and relatively high around 4% y-o-y. Inflation has decelerated to 3.1% y-o-y in November from 3.2% in October, but getting it much lower – towards the Fed’s 2% target, is starting to become much harder as the easy gains from sliding goods prices fade while upward pressure from sticky and some cases rising service prices continues.
In Australia, financial markets are also building in an expectation that the RBA will pivot towards cutting the official cash rate in 2024 although the rate cut expectations at around 50bps from the current 4.35% cash rate are much less pronounced than in the US. Australia is exhibiting softer economic growth than in the US (real GDP growth at 0.2% q-o-q or 0.8% annualised the US way in Q3 2023 and tracking about the same in Q4), but with still tight labour market conditions (unemployment rate up one notch to 3.9% in November, but on record high labour force participation rate of 57.2% and with Q3 wage growth at 4.0% y-o-y and pushing higher on recent wage settlements). Australian inflation is materially higher than in the US at 4.9% y-o-y on the latest monthly CPI reading for October and while decelerating is still a long way from touching down towards the top of the RBA’s 2-3% target.
The RBA is still a rare candidate to push the cash rate even higher in February if economic readings in January show less progress containing inflation than the RBA forecast back in the November Monetary Policy Statement. The Q4 2023 CPI out in late January needs to be down to 4.5% y-o-y (it was 5.4% y-o-y in Q3) to allow the RBA to stay on hold in February and prevent the need for the RBA to revise higher its inflation forecasts in the February Monetary Policy Statement.
Lags seem more elongated in the current economic cycle between higher interest rates cutting back demand and economic growth, and then feeding easier labour market conditions and eventually lower inflation pressure. Covid shutdowns and severe global supply chain problems through 2020 to 2022, massive fiscal spending on income relief boosting household savings and eventually releasing a flood of pent-up demand have led to a sharper lift and fall in demand for goods followed by a longer lift in demand for services are contributing to the longer and bumpier road returning inflation to the RBA’s target.
However, the signs that Australian economic growth is slowing and tentative signs that labour market conditions are not quite as tight as they were through much of 2022 and 2023 provide a case for slowing inflation in 2024. That may provide the RBA with leeway to start cutting interest rates from late next year.
Both in the US and here in Australia, we are likely to progress over the hump of high interest rates in 2024. The extent of cuts to official interest rates that markets are building in for 2024 is too great in our view given the slow and bumpy progress likely reducing inflation. The strong rallies in government bond markets in November and the first half of December have pushed too far and the risk of setbacks is high as markets build in a more realistic view of when and how much central banks can cut rates in 2024, about 75bps for the US Fed and 50bps for the RBA.
This is our last economic report for 2023. Wishing our readers, a safe and happy Christmas and a prosperous New Year. The first 2024 economic report will be published on Monday 15th January.