Developments within our current economic climate

• RBA warns interest rates to remain high until it is confident of further progress on inflation
• Federal Reserve to begin reducing US interest rates in September, usually a lead indicator of interest rate reductions in Australia
• Australian unemployment to track slowly higher

Key interest rate developments since last month: Our previous monthly report concluded the Q2 CPI outcome would allow the RBA to remain on hold in August, but that any early reduction in interest rates in Australia was unlikely as inflation remained too high for comfort.

That analysis was mostly on the mark however RBA communications revealed the Board seriously considered raising interest rates again in August concerned about a lack of further progress reducing inflation. While inflation is much lower than in 2022 and 2023, it has mainly tracked sideways around or slightly below 4% for the past year, rather than progressing toward the 2.5% rate the RBA hopes to achieve by the end of 2026.

The considerable uncertainties about the economic outlook and the desire to keep unemployment low saw the Board decide to leave interest rates unchanged at 4.35% but unusually also signal that it did not expect to reduce interest rates this year. While the Governor made clear this was not a commitment, a better message may have been that interest rates would not be reduced until the Board has greater confidence that inflation is making progress toward target.

Some assistance for Australian borrowers from US central bank developments: While the RBA’s message wasn’t welcome news, Federal Reserve Chair Powell also recently signalled the US central bank will begin to reduce interest rates in September. Lower interest rates in the US typically lead to lower Australian interest rates in time and this is already evident in declines in three-year and longer, term borrowing rates. However, until Australian inflation moderates further – or the RBA becomes more concerned about Australian unemployment– it’s likely that Australian cash rates, floating mortgage rates and overdraft rates will be reduced later and more slowly than interest rates overseas. A first interest rate cut here doesn’t look likely until late this year or early 2025. In part, that reflects the fact that Australian interest rates did not rise as far as those in other countries.  

If I had to choose just one indicator to assess how any economy was performing, I’d always choose the unemployment rate. When times are good, unemployment always declines – and vice versa. The best leading indicator of the unemployment rate in my experience is SEEK job advertisements. As the chart shows, rises and falls in job advertising are invariably followed by falls or increases in the unemployment rate, respectively. Importantly, RBA interest rate trends are also similarly signalled.

The current moderately declining trend for job advertisements suggests a further slow increase in the unemployment rate and is beginning to signal the next move in Australian interest rates is down, but not yet. If that trend easing in job ads were to accelerate, the first interest rate reduction could happen late this year. A much higher number of applications for each job advertisement also suggests more challenging conditions for job seekers and some easing of wages pressure.

Key Considerations for your Business:

• The past few years have been highly unusual. We counsel against simply extrapolating very recent business performance. 2019 baselines for activity are useful benchmarks, though prices have risen a lot since then.
• While overall growth in the Australian economy has slowed, employment has continued to grow, and the unemployment rate has remained very low. That helps prevent a greater slowdown.
• Importantly, there are few significant economic imbalances and there are signs that previous imbalances in labour and housing markets are now normalising, which should help inflation moderate over the next 12-18 months.
• Inflation has been moderating, but not as quickly as overseas. With the RBA having not raised interest rates as high as many of its overseas counterparts, it is not likely to be able to cut interest rates quite as soon or as quickly as overseas central banks, though some relief is now on the horizon (early 2025?). US interest rates are likely to begin falling in September, which will be helpful for Australian longer-term interest rates.
• If central banks act to lower interest rates over the next 6-12 months, there are good prospects that the fabled but rarely achieved soft landing can be stuck!