The Reserve Bank of Australia (RBA) has an ambitious plan to bring inflation back to its 2-3% target, while still maintaining close to full employment. The central bank’s own forecasts suggest that CPI inflation falls from 5.4% in Q3 2023 (having peaked at 7.8% y-o-y in Q4 2022) to 2.9% y-o-y by late 2025, while, on its forecasts, the unemployment rate rises by less than 1.0ppt from its trough. History shows a larger rise in the unemployment rate typically occurs when inflation falls by this much.
Seeking to maintain close to full employment while disinflating leaves policymakers with hard choices. For the RBA, any upside surprises to its own inflation forecasts could mean more monetary tightening, or a longer period of above-neutral interest rates. Our central case is that a tangible upside surprise to inflation is unlikely, but that the sticky nature of services inflation – particularly in rents and labour-intensive services – means inflation is likely to remain above target through 2024.
To disinflate, an extended period of suppressed demand is likely to be needed, weakening economic growth. Consumer spending is expected to weaken further. The housing market is forecast to cool, albeit significant supply constraints mean that we still expect positive single-digit growth in housing prices in 2024. As population growth slows, following exceptional strength in 2023, we expect this to weigh on growth. Demand for commodities and elevated commodity prices are set to support incomes and growth. We see GDP growth slowing from 2.0% in 2023 to 1.5% in 2024. On a per capita basis, we see GDP falling again in 2024.
Another year of Federal fiscal surpluses is expected, but fiscal policymakers still face tough choices. Any boost to net fiscal spending would support already high inflation. Already legislated income tax cuts that are due to arrive mid-year are set to support consumption and inflation, and state government spending programmes remain buoyant. A focus on productivity-enhancing reform that boosts the supply side of the economy would be the best way to help to disinflate the economy. In the absence of a marked supply-side improvement, demand will need to be suppressed for longer.
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