On the first shock – interest rates – the RBA has already lifted its cash rate by 400bp. The tightening of financial conditions this has delivered is working to slow growth, primarily by weighing on consumer spending. Household disposable incomes have been falling in real terms, hampered by high inflation, rising taxes, as well as the rise in interest rates. Household consumption is falling on a per capita basis.
Part of the reason for the powerful effect of higher interest rates is that most of Australia’s mortgages are at variable rates, so the transmission of the RBA’s tightening to the household sector has been rapid (in contrast, for example, to the US where most mortgages are fixed for 30 years).
The weakening of consumer spending has slowed the pace of overall GDP growth – which is below trend, albeit GDP is not falling outright (see The complicated consumer, 16 October 2023).
At the same time, though, the economy is being supported by a substantial surge in population growth.
The pick-up in population has been far greater than had been expected. As recently as late 2022, the government’s fiscal forecasts assumed that there would be net inward migration of 235k people in financial year 2022/23. The current run rate suggests that almost 500k people actually arrived.
Part of the reason for the surge is that many visas that were applied for during the pandemic, but not processed at the time because the border was closed, were subsequently approved when the border re-opened.
Another driver has been the return of international students, many of whom were enrolled, but studying virtually from offshore when the border was closed, but then moved to Australia when it was possible to do so. Foreign student number arrivals surged earlier this year and are back above the pre-pandemic levels.
For the economy, the surge in inward migration boosts both demand (for goods, services and housing), and supply (primarily of labour).
Most obviously, the migration surge has delivered a vivid effect on the housing market (a point we have been making since earlier this year, see Housing prices steadying earlier than expected, 19 April 2023).
Even though interest rates have risen and housing prices had initially fallen as a result of this tightening, they have been rising recently due to the population surge.
Standard forecasting models suggest that a 400bp rise in interest rates might typically see housing prices fall by 15-20%; however, housing prices fell by only around 10% between mid-2022 and early 2023, before rising by 8% since then.
The surge in population growth helps to explain the turnaround. These models also include measures on rental yields that respond to the balance of supply and demand in the housing market. The surge in inward migration has been a surprise, which has driven a sharp fall in rental vacancy rates and a rapid rise in rents, which have in turn also supported housing prices, despite the rise in interest rates.
Stronger-than-expected population growth has also boosted demand for goods and services. Although per capita household consumption has been falling – as we describe above and is evidence that monetary tightening is working – overall household consumption growth is still positive, despite slowing. With many more people in the economy, there are also many more consumers.
Strong inward migration is also boosting labour supply. Partly as a result of this, the labour market is loosening, albeit very slowly. New migrants are filling roles, and helping to meet some of the acute skills shortages that were apparent in 2022.
For monetary policy the key is to assess the balance of these positive and negative shocks for growth and inflation. Our model-based estimates suggest that a positive shock to migration is net inflationary in the short run (see Migration and inflation, 22 June 2023).
Importantly, managing this sort of challenge is one of the great strengths of an inflation-targeting regime (see Inflation targeting Downunder: Is IT really it?, 6 April 2018). Inflation reveals the nexus of demand and supply in the economy. If inflation is higher than target, or rising, then demand may be too strong and, if it’s lower, the opposite could apply.
Last week’s inflation print provided a clear signal that underlying inflation is not falling as fast as the RBA had been expecting. The central bank had been forecasting that the trimmed mean would fall to 4.8% y-o-y in Q3, but the print was 5.2% y-o-y. That is a material upside surprise.
Much of the strength in inflation is being driven by services prices. Rents are part of this story, but the momentum in inflation is fairly broad-based
Amongst the many factors at work, the significant upside surprise to population growth is playing a role. Given the magnitude of the upside surprise to population growth, it should perhaps be unsurprising that inflation is still stronger than was expected.
Our view is that the RBA will lift its cash rate by 25bp in November. Although inflation is down from its peak rate and the jobs market is slowly loosening, getting inflation back to the RBA’s target band by the second half of 2025 (as the central bank is aiming for) will likely require some further tightening of financial conditions.
This is a Free to View version of a report with the same title published on 30-Oct-23. Please contact your HSBC representative or email AskResearch@hsbc.com for more information.