This week’s national accounts confirmed our view that the domestic economic is soft, especially the consumer. Pressures on households should start to ease in the period ahead.
The big-picture themes from the national accounts for the December quarter were largely as expected. The Australian economy is soft, expanding just 0.2% in the quarter and 1½% over 2023 as a whole. Domestic demand in the December quarter was weaker still, especially in the private sector. Almost all the 0.1% increase in domestic demand in the quarter came from the public sector.
Much of 2023’s weakness stemmed from the household sector. Consumption has been weak and this remained the case in the December quarter. Discretionary spending continues to decline, with overseas holidays especially weak. Part of this might be the result of shifting seasonal patterns in spending and holidaying. Even so, households are objectively limiting their spending in the face of income pressures. Consumption per person has been falling in Australia, unlike in most peer economies. It is no wonder that consumer sentiment has been so depressed.
We have been highlighting these income pressures for some time. The triple squeeze of a rising cost of living, increasing tax take and higher interest rates has required households to respond.
It has been less recognised that the squeeze from rising taxation as a share of income has been greater than from rising net interest payments. (Indeed, the ABS revised down the interest flow series this week, relative to previous releases.) This does not mean monetary policy has done little to slow the economy or combat inflation – there are other channels of monetary policy transmission beyond the immediate effect on household cash flows. But it does put the role of fiscal policy, and particularly bracket creep, in perspective.
There is light at the end of the tunnel for households. As inflation has declined, the squeeze on real household incomes from this source has diminished. The drag from taxation and net interest payments has also eased a little. Some of the former might reflect timing effects for tax return lodgements. Meanwhile the November increase in the cash rate would have taken effect in people’s debt repayments too late to have boosted the quarterly total for net payments by much.
As a result, real household disposable income increased in the quarter. It was only barely above the level a year previously, though. Once the growth in population over the same period is accounted for, real household disposable income is still going backwards.
Inflation’s grip on households’ spending power will continue to ease over the course of 2024. That is the desired outcome. With tax cuts – and, we believe, some reductions in the cash rate – coming in the second half of the year, that triple squeeze will truly begin to unwind.
It would not be appropriate to interpret the coming turnaround in real incomes as an upside risk that threatens an upsurge in demand-driven inflation. Rather, it represents an extraordinary phase in the household sector’s experience coming to a close. Two years of declining real incomes in the face of a tight labour market is not a combination that should be regarded as normal. And there are some potential offsets to this turnaround, especially from the labour market, which is expected to slow with a lag given current slow growth in activity. There are also some increases in net interest payments yet to come through.
Businesses have also adjusted to the slow demand. Some of them have run down their inventories, while investment in new equipment declined in the quarter. Consistent with our forecasts, the resilience that was believed to have prevailed in the first half of 2023 has not carried through into the second half. Activity in non-residential construction has held up, and opportunities in energy transition, resources and elsewhere remain. But with ongoing cost pressures and soft demand, many businesses would understandably seek to delay or rationalise their spending on new equipment.
The RBA would be comfortable with these outcomes. They have been seeking to slow demand because they want to bring the level of demand back into balance with supply. The December quarter outcome certainly helps achieve that objective. It also supports our house view that the RBA will reach the point of being prepared to reduce some of the contractionary stance of policy late in the year, most likely starting from September.
The RBA would also have been heartened by the ongoing turnaround in labour productivity, which increased as they – and we – expected. The second consecutive quarterly increase in this series does not make a trend. But it does lend weight to our view that much of the earlier slump was an artefact of the population surge. Over time, the capital stock will catch up – as long as investment does not decline precipitously.
Where they might be less comfortable is on the housing front. The potential wealth effect of a renewed upsurge in housing prices is unlikely to be the main concern given any additional consumer demand needs to be set against the weak starting point.
Rather, the issue at present is the low rate of new production of housing in the context of high construction costs and ongoing (if more moderate) population growth. New housing construction is one of the most important channels of the transmission of monetary policy, here and overseas. The current low rate of dwelling investment is therefore an expected outcome of the RBA’s policy actions. To the extent that higher interest rates have dampened dwelling investment, however, they exacerbate Australia’s current housing affordability challenges in the medium term. These challenges also relate to some of the other headwinds affecting the industry, including the competing bid for resources from non-residential construction. The inflation–employment trade-off is therefore not the only short-term policy dilemma that policymakers must navigate.
