Statement on Monetary Policy – May 2024Overview

Key messages

Inflation remains high and is falling more gradually than expected.

Recent data confirm that inflation continues to moderate but more gradually than expected. Services inflation has peaked but remains high. Domestic cost pressures remain elevated and conditions in the labour market have eased by less than anticipated. Taken together, this information suggests that the labour market is tighter than previously thought.

Higher interest rates are expected to bring demand into better balance with supply. The staff’s assessment is that the stance of monetary policy in Australia is currently restrictive, based on financial indicators and the ongoing easing in the growth of aggregate demand. Demand growth is expected to be subdued over 2024 and employment growth is expected to slow but remain positive. As demand comes into better balance with supply, inflation is expected to reach the target range of 2–3 per cent in the second half of 2025 and to reach the midpoint in 2026.

The cash rate target is unchanged to support inflation returning to target.

At its May 2024 meeting, the Reserve Bank Board decided to hold the cash rate. The Board expects that it will be some time yet before inflation is sustainably in the target range. Returning inflation to target within a reasonable timeframe remains the Board’s highest priority. Keeping the cash rate at the current level supports continued progress of inflation to the target and moderate growth in employment.

The outlook remains uncertain. The path of inflation on its return to target is unlikely to be smooth. The path of interest rates that will best ensure that inflation returns to target in a reasonable timeframe remains uncertain and the Board is not ruling anything in or out. The Board will rely upon the data and the evolving assessment of risks and remain vigilant to the risks of inflation remaining too high.

What’s going on in the economy?

Global economic growth has remained subdued and inflation is above target in many economies.

Economic growth has been soft across most advanced economies, although some recent indicators have been more positive. In many countries, subdued economic growth has been driven by sluggish household consumption – although the United States has been an exception to this, with domestic demand and household consumption growth remaining strong.

Timely indicators of business conditions have lifted in some advanced economies; recent increases in some commodity prices also point to some pick-up in global demand. Consistent with this, economic growth in China picked up in early 2024, driven by a rebound in household consumption and stronger external demand. The prices of iron ore and coking coal (which are key Australian exports) have partially recovered from sharp declines earlier in the year as the outlook for the Chinese economy has improved.

Inflation remains above target in most advanced economies and progress in lowering inflation has slowed in some. Core services inflation remains elevated abroad and the latest US data in particular have surprised to the upside. There are also some signs that disinflation in core goods prices may have run its course in some economies.

The expected timing of global policy easing has been pushed out.

Market participants generally expect that policy rates have peaked in most advanced economies. But they also expect that policy will be eased more gradually than was anticipated a few months ago, consistent with central banks’ own communications. Yields on government and corporate bonds have increased alongside increases in policy rate expectations. At the same time, a range of asset prices, including for equities, remain elevated and conditions in international wholesale funding markets remain favourable overall, reflecting market expectations that restrictive monetary policy will see inflation ease without a substantial downturn in economic activity.

In Australia, the expected path for the cash rate has shifted up since the February Statement.

Market participants revised up cash rate expectations in response to stronger-than-expected Australian inflation and labour market data. Market pricing implies there is some chance of one more rate increase in Australia this year, with no reduction in the cash rate expected until 2025. Indeed, market participants expect policy to be eased more gradually and noticeably later than previously anticipated. As was the case previously, rate cuts are expected to be fewer and to begin later than in peer economies.

Economic growth has remained subdued, but the level of demand still exceeds supply.

The monetary policy tightening to date has contributed to a noticeable slowing in the growth of demand over the past year. Most of the increase in the cash rate since May 2022 has been passed on to borrowers. For households, this has led to a significant rise in the share of incomes used to meet debt payments, which, along with high inflation, has put pressure on household budgets. Household credit growth has been subdued in the face of higher interest rates.

The overall level of demand has continued to exceed the economy’s supply capacity but the gap is narrowing as restrictive monetary policy flows through the economy. Very weak household consumption growth has more than offset strong growth in business investment and public demand. Households have reduced their spending: saving has been higher than expected, which appears to be supported by the current high-interest-rate environment.

The supply of housing has fallen short of underlying demand. Housing supply has been hampered by ongoing capacity constraints and increases in construction costs, while demand has been supported by strong population growth and the shift in preferences for more housing space. As a result, both housing prices and rents have continued to rise.

Labour market conditions have been easing but remain tight relative to full employment.

Labour market conditions have eased more gradually than was anticipated in the February Statement. Employment has grown in line with the working-age population, and the participation rate and employment-to-population ratio remain near record high levels. The unemployment rate remains only modestly above its late-2022 trough. Much of the easing in labour market conditions over the past year has occurred through declining average hours worked and can also be seen in fewer job vacancies.

Wages growth has been a little stronger than expected but may be around its peak. Growth in wages for workers on individual arrangements, whose wages tend to be more responsive to current labour market conditions, has eased somewhat. Recent business liaison also suggests that growth in wages is expected to moderate over the year ahead. Unit labour cost growth is elevated but has moderated slightly in line with the pick-up in labour productivity growth late last year.

How do we see the economy developing?

Subdued economic growth is expected to pick up gradually at home and abroad.

While global conditions look to have improved, growth in Australia’s major trading partners is expected to remain subdued for the next year or so. The IMF has revised up a little its outlook for global growth and risks to the global outlook have become more balanced. The near-term growth outlook for the United States and China has been revised higher, although the impact of those revisions on trade-weighted demand for Australian exports has been offset by downward revisions in other trading partners.

In Australia, past monetary policy tightening and associated weak consumption growth is likely to weigh on economic growth in the near term. Households have reduced their spending and saved more than expected. Consumption growth is expected to remain subdued for most of 2024. The near-term forecast for GDP growth has been revised down a little compared with the forecasts published in the February Statement.

A recovery in real incomes is expected to support a pick-up in household spending. From late 2024, GDP growth is expected to pick up gradually as household consumption growth recovers. Dwelling investment growth is also expected to pick up from around mid-2025, reflecting increased demand for new housing from recent population growth, higher prices for established housing and improved conditions in the construction industry.

The labour market is expected to ease gradually over the next couple of years. Labour market conditions have proven stronger than expected and the unemployment rate is expected to increase more slowly than thought at the time of the February Statement. Much of the labour market adjustment is expected to continue to occur through declining average hours worked and fewer job vacancies. As labour demand eases, employment growth and nominal wages growth are expected to moderate gradually.

Inflation is expected to reach the target range of 2–3 per cent in the second half of 2025.

Inflation is expected to be higher in the near term than anticipated at the time of the February Statement. Services inflation has declined by a little less than expected, the labour market is assessed as being tighter than previously thought and the outlook for the labour market is slightly stronger. Higher petrol prices and the legislated end of energy rebates will also lift headline inflation in the near term.

The forecasts assume that the cash rate is higher for longer. The staff forecasts are conditioned on the assumption that the cash rate target remains around its current level until mid-2025 before gradually declining over the remainder of the forecast period. This path is about ½ percentage point higher from 2025 onwards than in the February Statement.

The higher cash rate path in the forecasts supports the return of inflation to target. Tighter monetary policy dampens expected real economic activity, closing the gap between demand and supply and reducing inflationary pressure in the second half of the forecast period. Inflation is expected to reach the target range of 2–3 per cent in the second half of 2025 and to reach the midpoint in 2026. Inflation expectations are expected to remain consistent with achieving the inflation target.

Key risks to the outlook

The staff assess the risks to the domestic outlook to be broadly balanced. The recent flow of data suggests that the risk that inflation takes longer to return to target than anticipated has increased. The labour market is tighter than anticipated and businesses’ production costs could increase further if productivity growth were to remain weak. At the same time, the risk that demand is weaker than expected is still present, with recent labour market and consumption data providing different signals about the strength of domestic demand. Weaker demand growth would lead to more spare capacity and dampen inflationary pressures.

Costs associated with the upside risk to inflation are greater than the costs of downside risks. The longer it takes for inflation to return to target, the greater the risk that inflation and wage expectations drift higher. History shows that, should this occur, it would require more monetary policy tightening and a costly period of higher unemployment to stabilise inflation expectations and return inflation to target. Downside risks to the outlook for economic activity would see a faster return to the inflation target, likely at a cost to the employment objective.

What did the Board decide?

The Board decided to hold the cash rate. The Board expects that it will be some time yet before inflation is sustainably in the target range. Recent data indicating that labour market conditions are tighter than previously thought and that inflation is falling more gradually than expected demonstrate that the path of inflation back to the target range of 2–3 per cent is unlikely to be smooth.

Today’s decision supports the dual objectives of monetary policy. It balances the return of inflation to target in a reasonable timeframe with gradual easing in labour market conditions to levels consistent with full employment. The path of interest rates that will best ensure that inflation returns to target in a reasonable timeframe remains uncertain. It will depend upon the data and the evolving assessment of risks, and the Board is not ruling anything in or out.