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Australian households carry the burden for another year.
Our last Brief of 2023 outlined the major surprises for the year that was: the outperformance of the global economy (driven largely by upgrades to consumer spending), but with inflation held in check by additional increases in interest rates. In contrast, Australia’s economy grew largely in line with expectations last year, with GDP estimated to have grown by a below-trend 1.9% in 2023, up only slightly from a Consensus Forecast of 1.6% at the start of 2023. In stark contrast to the global economy, consumer spending surprised on the downside in Australia in 2023.
Why did Australian households spend less than forecast over 2023?
Part of the explanation lies with the interest rate response that occurred globally and domestically. Global central banks took interest rates ever higher over 2023 to ensure inflation trended toward target rates. With Australia lagging the global inflation cycle by roughly six months, the RBA took the cash rate from 3.10% to 4.35% over 2023, when expectations had been for it to be around 3.4%. Household borrowing in Australia is concentrated in variable rate loans which move closely with short-end rates, so this pushed the interest burden on mortgage holders sharply higher. As a share of disposable income, mortgage interest payments are currently 2.5 times higher than the start of 2022.
Higher inflation rates in Australia also impacted real incomes, despite relatively robust nominal income growth. And rising wages meant that bracket creep pushed many households into higher tax brackets, further damping real disposable income growth. The triple-whammy of rising prices, interest rates and taxes left real household disposable incomes falling by 4.3% in the year to September, their weakest rate in 40 years. Hardly any wonder households were feeling the pain and not in the mood to spend.
If incomes were falling so sharply, why didn’t the consumer collapse?
In per-capita terms, consumer spending is weak, having declined for the last four consecutive quarters. For 2023, we estimate consumption per capita will fall by around 1%. But the sheer number of migrants has added to the demand for goods and services (as well as boosting supply). This has helped sustain a modest expansion in aggregate consumption, and real GDP.
Even this modest growth in household consumption has required a rundown in the saving rate to historically low levels. Households are using some of their savings built up over the Covid period to sustain spending in the face of rising costs of living. This pool of savings has declined but remains around $200 billion. Households can continue to use this pool of savings to support spending over 2024 and into 2025.
Will the Australian economy tip into recession this year?
Recession is a risk, but not our central case. Critical to the outlook for the economy is where disposable incomes go from here. And the news is better on several fronts. Firstly, inflation is abating. It has slowed from 7.8% at the end of 2022 to around 4.5% at the end of 2023 and will likely end 2024 only slightly above the RBA’s target band. This ensures there will be no more RBA rate hikes this year. Indeed, the prospect for rate cuts will be brought to the table in H2’24, although we expect the RBA to hold off cutting rates until early next year when they are confident inflation has been tamed. Households will also benefit from Stage 3 tax cuts which come into effect from July. If the labour market can hold up, real disposable incomes will start to improve later this year and help put a floor under household spending.
It seems the critical question is whether or not the labour market will hold up?
We believe it will. Despite the migration-fuelled 3% (or 600k) rise in working age population over 2023, the unemployment rate has only risen by half a percent from its lows in late 2022 and remains low, at below 4%. Demand for labour has been resilient as firms attempt to rebuild workforces and address skills shortages following the Covid dislocation. Job vacancies data continues to moderate only gradually, and reports from employer groups suggest worker shortages remain elevated, so the slowdown in employment growth should be quite moderate. We are expecting employment growth to slow from over 3% in 2023 to 1.3% in 2024.
Coupled with a slowing in the pace of net overseas migration which will slow the growth in working age population toward 2%, we expect the unemployment rate to rise to 4.5% by the end of 2024. GDP growth will slow over 2024 to 1.3%, which would be a second consecutive year of below-trend growth. So while 2024 may feel like another difficult year for households, towards the end of the year we are expecting to see signs of an improvement in growth and decline in inflation, indicative of a Goldilocks-style recovery in 2025.