Australian economic growth has slowed through the first half of 2024 to 1.0% y-o-y from 1.6% y-o-y in the second half of 2023 and 3.7% y-o-y in the first half of 2023. At face value, that is the order of growth slowdown that could ease inflation and allow the RBA to start cutting the cash rate, although not until next year in our view.
One issue is that the softness in household spending that held back GDP growth in Q2 (real household consumption fell 0.2% q-o-q) is likely to turn stronger in Q3 off a sharp lift in real household disposable income from the July 1st tax cuts, working together with other boosts to disposable income from wage growth and interest payments on debt that have peaked out.
In the second half of 2024, it is unlikely that annual economic growth will slow further below the 1.0% y-o-y in given that the quarter-on-quarter economic growth rates have stabilised at 0.2% in each of the last three quarters (Q4 2023 to Q2 2024) and that there are many reasons including firmer household spending growth as well as very strong government spending growth (real government consumption spending was up 1.4% q-o-q, 4.7% y-o-y in Q2 and appears to be accelerating) to expect firmer than 0.2% q-o-q GDP growth for Q3 and Q4 2024 pushing annual GDP growth up nearer to 2.0% y-o-y.
The growth slowdown through to Q2 2024 has been just about enough to allow the RBA to hold the cash rate at 4.35% and eliminate the need for further rate hikes, but in our view, it is not enough yet to provide a case for the RBA to start cutting the cash rate this year, especially with growth acceleration in prospect for the second half of 2024.
An economic growth acceleration would not matter to the RBA if there was some evidence that output is likely to grow at least at the pace of demand in the economy. In Q2 productivity went backwards, with GDP per hour worked down by 0.8% q-o-q and up only 0.5% y-o-y. At this stage, there is no sign of the improvement in productivity that the RBA hoped might happen in mid-2024.
As a result of continuing weak productivity real unit labour costs rose in Q2 by 1.3% q-o-q, or 2.0% y-o-y. This still strong underlying cost pressure running in the Australian economy means that even though parts of demand in the economy were weak in Q2, they have to stay weak if inflation is going to come down.
The growth in real unit labour costs in Q2 also means that wage growth running at 4.1% y-o-y according to the Q2 wage price index is too high and will need to moderate to 3.5% y-o-y or less to ensure inflation comes down sustainably below 3% over the next 18 months.
The Q2 GDP report with its evidence of households cutting back consumption spending is not going to push the RBA to start cutting the cash rate later this year. Rather, the evidence of too strong government spending and still too weak productivity mean that reduction in underlying inflation still sitting up close to 4% y-o-y is still at least the protracted affair highlighted in the RBA’s latest economic forecasts published in the August Monetary Policy Statement.
While the RBA continues to forecast that it will take until 2026 to get inflation back inside 2-3% target there is no real hope of the cash rate starting to be cut until some time in 2025.
The next review of the RBA’s economic forecasts will be in November. Ahead of that review the RBA will have to hand two more monthly reports relating to retail sales and the labour market as well as the Q3 CPI out in late October. It is unlikely that these reports will force a change in RBA position in favour of a rate cut in November or December.
These reports would need to weaken sharply and lead the RBA to lower its economic growth, wage growth and inflation forecasts in the November Monetary Policy Statement. The likelihood is very low of such forecast changes given that the tide is turning in favour of stronger growth in household disposable income growth in Q3 and the Federal and State Governments appear to be doubling down on temporary support payments and subsidies to help counter the impact of the high cost of living for households.
GDP growth was slow in Q2, but that was what is needed to provide any hope of inflation eventually returning inside target band. We see the Q2 GDP report not as a reason why the RBA may cut the cash rate before the end of this year, but instead as a strong confirmation of why the first rate cut will be delayed until 2025.