20 JULY 2023: Surprising resilience in the global economy has allayed immediate concerns about a global recession. Despite this, the broad narrative remains largely unchanged – global economic growth is still likely to be significantly slower in 2023 than in the previous calendar year as tighter monetary policy continues to hinder activity.
Meanwhile, the outlook for the Australian economy has softened further. The Reserve Bank of Australia (RBA) has increased interest rates by more than previously expected and Deloitte Access Economics forecasts the Australian economy to grow by just 0.9% in the 2023-24 financial year. For comparison, the economy grew at an average annual rate of 2.4% over the previous the decade, and 2.6% in the decade before the pandemic.
Releasing the June 2023 edition of the flagship Business Outlook report, Deloitte Access Economics Partner and report lead author, Stephen Smith, said: “The outlook is much worse when removing the effect of population growth. A deep per capita recession is expected over the next two years. In 2025, economic activity per person in Australia is expected to be around the same as in 2021, indicating that prosperity has stalled.
“While the RBA paused in July, the full effect of the 400 basis points of interest rate increases to date is yet to be seen. Deloitte Access Economics remains concerned that too much has already been done by the RBA given that most of the inflation in the system stems from supply side issues – a fact confirmed in recent research by the RBA itself – and is therefore largely immune from monetary policy. At the same time, flagging productivity and soft business investment are a reminder of broader challenges facing the Australian economy.
“Price growth which is primarily caused by issues of supply – be it global shipping costs and import prices, the costs of a disorderly energy transition, or higher rents and house prices because of a handbrake on housing construction –cannot be readily solved by higher interest rates.
The danger that monetary policy has already been tightened too much – a danger that Deloitte Access Economics has been consistently warning about for several months – is more than evident in recent economic data.
“The pace of inflation has peaked and is moderating, wage growth is not excessive and medium-term inflation expectations are not rising,” Smith said. “In that context, the RBA was right to pause at its meeting in early July and wait for more information about the effect of previous increases in interest rates.
“It was notable, however, that outgoing Governor Lowe dropped a reference to keeping the economy on an “even keel” in his statement announcing the Julys monetary policy decision, despite those words appearing in each of the ten preceding statements dating back to August 2022. Instead, the July statement said the RBA Board “is still expecting the economy to grow”. That’s a considerably lower bar.
“The current disinflation impulse reverberating through developed economies is neither a surprise nor likely to be short-lived, and will flow through to lower headline inflation in Australia over coming quarters.
In fact, this has already started to occur. For example, prices of imported final consumer goods declined by 2.4% in the March quarter of 2023 and are up by just 3.8% on a year-on-year basis. Prices of imported intermediate inputs fell by 6% in the March quarter, which should flow through to softer prices faced by Australian consumers in subsequent periods.
Hence the easing of global supply chain pressures, and a soft economic outlook overseas have led to a switch from imports being a major source of inflation in 2022 to a key driver of disinflation going forward.
However the trend toward normalisation in core inflation is likely to unfold more slowly, with deceleration in one area offset by acceleration in another.
Growth in rents as recorded in the inflation data continues to trail well below more contemporary measures of rents for new and renewed leases. Rental vacancy rates remain at or around all-time lows in almost every capital city and most regional areas, and the policy effort to fund the construction of additional affordable housing is unlikely to address housing supply shortages in the near term.
“At the same time, further significant increases in electricity costs will be partially offset by government relief payments, Smith said. “But these payments do not address the root cause of shortages of supply in wholesale markets putting upward pressure on retail electricity prices.
“For this reason, we remain of the view that rising housing and utilities costs will lead to a more gradual deceleration in the various measures of underlying inflation in Australia than has been observed in other countries to date.”
Deloitte Access Economics forecasts underlying inflation to average 4.2% in 2023-24 and return to the RBA’s target band of 2-3% in 2024-25.
“And what about the extent to which excess profits are driving inflation?” Smith said. “It doesn’t make for a sexy headline, but “it’s complicated” would be a reasonably accurate answer.
“Is there evidence of systemic price gouging and excessive profits across the Australian economy, such that it is a key source of inflation? No. But are there examples of market power, weak competition, duopolies and oligopolies in key sectors, which are likely contributing to poor productivity growth and higher prices for some goods and services? Absolutely. Anyone who has purchased goods or services from the banking, airline, supermarket, insurance or telecommunications sectors in Australia could tell you that.
“Overall, the profile for the normalisation of inflation is achievable with the monetary policy decisions already taken. That is, unless circumstances change significantly, the evidence does not support any further increases in the cash rate target.
“Indeed, defence against the supply side challenges which are driving underlying inflation in Australia needs to come in the form of a wider set of economic policies, namely fiscal policy, investment and innovation to lift productivity, competition policy to improve efficiency and erode market power, and tax policy to boost prosperity.”
The outlook for Australian industries is ever more reflecting the increasingly challenging domestic economic conditions. Elevated yet moderating inflation and increasing interest rates have combined to slow household spending and economic growth. A softer outlook across the different industries reflects these developments.
“The brunt of the current consumer crunch is being felt by retailers, who are staring into the considerable challenge of a ‘retail recession’,” Smith said. “On the other hand, the upside for the sector – and for the economy more broadly – is the pace of population growth.”
States and territories
“The outlook across Australia’s states and territories reflects the deepening slowdown affecting the economy,” Smith said.
“Those in in the south-east are relatively more exposed to higher interest rates and cost of living pressures given larger mortgages and the importance of the housing sector and consumer spending in supporting economic activity.
“However, the economic outlook has now also darkened for Western Australia and Queensland given China’s wobbly economic recovery from the pandemic.”
Key forecasts: Deloitte Access Economics Business Outlook, June 2023
Business Outlook is a quarterly publication presenting detailed economic forecasts and commentary to help understand the economic forces shaping the business environment. The forecasts cover a detailed assessment of the national economy, world growth prospects, each of Australia’s states and territories, and industries.