Australia to avoid technical recession, but inflation to keep rate cuts off the agenda until Q4 this year: Oxford Economics Australia
Globally, returning core inflation back to two per cent set to be a challenge
Emissions not dropping fast enough, Australia likely to miss our 2030 targets by a couple of years
Varied performance anticipated for both residential property prices and rental metrics in 2024
Total construction work done expected to fall in real terms through year for first time since 2020
Monday, March 18, 2024 – Brisk population growth is expected to be the key pillar of Australia avoiding a technical recession, but the issue of inflation – as it is globally – is set to persist in 2024, with impacts across all sectors of the Australian economy.
This is the key takeaway from Oxford Economics Australia’s bi-annual economic outlook conference, taking place in Sydney tomorrow (Tuesday, March 19) and Melbourne on Thursday (March 21). The full-day conferences will explore the major economic outlook and trends for the year ahead and navigate where opportunities for growth can be found. Afternoon sessions will provide delegates an opportunity to get a deep dive into major sectoral topics from Construction, Real Estate, Housing, Climate & Sustainability.
Oxford Economics Australia’s economists – along with the CEO of Oxford Economics globally, Adrian Cooper – are releasing some of their key findings ahead of the conferences. More analysis and forecasts will be unveiled at each conference, including: the impact of impact Artificial Intelligence have on long-term growth; which sectors are contributing the most to decarbonising the Australian economy; whether anticipated interest rates cuts from late 2024 will trigger another growth spurt for home prices; and whether we will build enough renewable generation to hit our energy targets.
Global Economic Prospects and Risks
“Headline inflation globally has fallen markedly,” said Adrian Cooper, CEO, Oxford Economics. “A big part of that is that rises in energy prices triggered by the effects of Russia’s invasion of Ukraine are falling out of the annual comparison. In addition, though, we have swung from a situation where, during Covid, supply chain pressures were leading to shortages and sharp increases in traded goods prices, to a situation now where supply chain pressures are unusually light.”
However, while goods price inflation has collapsed, inflation in the service sector remains high, and that reflects still-high wage inflation. And while wage inflation has fallen from its peak, it is still well above the rate consistent with central banks’ inflation targets, especially given the weakness of productivity growth.
“Getting core inflation back to two per cent is going to be a challenge,” said Cooper. “It might happen first in the Eurozone given the weakness of the economy. But it’s not expected to happen in the US or UK in 2024.”
As for the implications of the US elections, Cooper believes it is important to emphasise that it is not just who wins the White House that matters, but also who controls Congress. In all cases, Oxford Economics sees the US fiscal position remaining lax, with borrowing of at least 5-6 per cent of GDP for many years.
“But if we were to see a situation where not only does Donald Trump become President again but also the Republicans win control of both Houses of Congress, we can expect significantly looser policy – bigger tax cuts and spending – that may boost growth in the near term but lead to levels of borrowing that may well lead to turmoil in financial markets in the medium term,” said Cooper.
The economic outlook for Australia: Navigating the economic slowdown
“The Australian economy is enduring a policy-induced slowdown. Both fiscal and monetary policy are at or close to the peak drag they will impose on the economy in this cycle,” said Sean Langcake, head of macroeconomic forecasting for Oxford Economics Australia. “Still, with cost pressures proving to be persistent and elevated, the lingering inflation problem has not yet been cured.”
Brisk population growth in 2024 will again be Australia's best bulwark against a technical recession as it was in 2023. The period of very strong population growth does not appear to have upset the balance of demand and supply in the labour market. Key labour market ratios such as employment-to-population, the participation rate, and the unemployment rate all broadly tracked sideways over 2023. This suggests that the additional labour supply that has come from a growing population has been largely met with increased demand. But this balancing act may become more difficult in 2024 as labour demand wanes.
Segments of the economy where supply cannot respond quickly – principally the housing market – are showing greater signs of strain, with rent inflation set to continue through 2024.
“We expect strong population growth will ensure that Australia stays out of recession,” said Langcake. “But policymakers will need to walk a fine line to ensure cost of living pressures do not overwhelm vulnerable households, inflation returns to target in a timely fashion, and the labour market remains close to capacity.”
Meanwhile, while the budget bottom line may be unchanged, the redesigned tax changes will have a larger multiplier effect as it distributes income toward those with a higher marginal propensity to consume. Accordingly, these changes present some upside to the outlook for FY25.
The Treasury expects the changes will not materially impact the outlook for inflation. This seems an optimistic outlook, and Oxford Economics believes these changes may prolong the wait for the first RBA rate cut.
“We do not expect to see rate cuts until Q4,” said Langcake. “The next part of the disinflation cycle will be tougher. The ‘easy wins’ from supply chain improvements have already been realised, and the end of cost-of-living subsidies will see an increase in inflation in some components.
“Moreover, cost pressures on the services side of the economy remain elevated, and rent inflation is set to continue at a brisk pace. Until these upside uncertainties resolve, the RBA will be reluctant to ease policy.”
Taking stock of Australia’s journey to net zero: Where are we at and what’s to come?
“We’ve taken stock of Australia’s journey towards net zero and the good news is that emissions are dropping,” said Kristian Kolding, Head of Consulting for Oxford Economics Australia. “The bad news is that emissions aren’t dropping fast enough.
“Our most likely forecast scenario suggests we’ll miss our 2030 targets by a couple of years as the roll out of renewable energy is taking longer than expected. But more worrying is the fact that we don’t currently see a path to meaningfully decarbonising hard to abate industrial sectors and electrifying the vehicle fleet will take decades.
“Despite the dour outlook, credible paths to net zero do exist. Technological advancements and policy initiatives are steering the forecast in that direction, but the cost of transition will be high and we’re yet to see who is willing to pay.”
With interest rates nearing a turning point, where to for Australian real estate?
“The run up in interest rates has provided a drag for all asset classes, but other cyclical and structural drivers are becoming more prominent in determining performance,” said Maree Kilroy, senior economist for Oxford Economics Australia. “Underlying demand has been robust in many sectors, backed by the strongest population growth increment on record. Migration is running red hot but should soon normalise.”
Buoyed by a resilient buy side, residential property in all the major markets brushed off higher borrowing costs over 2023. Moving further into 2024, regional discrepancies are growing, and more varied performance is anticipated for both price and rental metrics.
“There is plenty of action on the policy front to boost housing supply, including planning tweaks and incentives for institutional investors,” said Kilroy. “Commercial valuations have been hit by a run-up in borrowing costs, and transaction volumes have slowed to a crawl. Some tailwinds are fading while structural headwinds are also impacting key asset classes, notably the rise of hybrid work arrangements and technological change.”
Meanwhile, all the major office markets across Australia are oversupplied. On the demand side, net absorption is being hit by a drawn-out return to the office and the impact of hybrid working arrangements. At the same time, new office development is being rolled out across many markets. On the investment side, rising interest rates have flowed through to higher property yields, triggering a setback to capital values.
“But there is light at the end of the tunnel,” said Lee Walker, Principal Property Economist for Oxford Economics Australia. “We believe that the trough is in sight and whilst the recovery may not be quick, pieces are falling into place to underpin reasonably attractive prospective medium to long term returns.”
Oxford Economics Australia forecasts that industrial property is moving from a period of extraordinary returns to lower but still reasonably healthy returns. After a very strong run, momentum is coming out of the eastern seaboard industrial property markets. Pandemic related drivers of occupier demand are fading, and supply is starting to catch up, which will push up vacancy rates and take the heat out of rental growth.
“In the near term, we think occupier demand will weaken further as economic growth slows, but not enough to create notable oversupply,” said Walker.
Is the construction sector heading for a hard landing?
“The Australian construction sector is facing a challenging period as costs and capacity constrain activity levels,” said Dr Nicholas Fearnley, head of global construction for Oxford Economics Australia. “Publicly funded activity continues to be supported by large investments in transportation and social building projects.”
“We believe residential commencements are near the bottom of the cycle” said Timothy Hibbert, Head of Property and Building Forecasting for Oxford Economics Australia. “Forward leads including development enquiries, land sales, and construction finance, which have improved in recent months, especially for houses.”
On the non-residential building front, further easing is forecast to mid-decade. A slowdown in private investment has materialised in response to higher development costs and sector specific headwinds that have seen commercial asset transaction volumes dive over the last year.
“Overall, calendar 2024 marks a turning point in the construction and infrastructure industry in Australia, with total construction work done expected to fall in real terms through the year for the first time since 2020,” said Adrian Hart, Head of Construction and Infrastructure Consulting for Oxford Economics Australia. “While some sectors are feeling more pain than others, in aggregate the sector is a long way from a ‘hard landing’. Civil and social infrastructure activity continues to grow apace, with growing investment in utilities, social building and resources infrastructure is presenting regional opportunities and challenges.”
Growth in construction costs has eased significantly over the past year, but overall costs have not fallen following the surge in prices between 2021-23. Key published measures of construction costs show growth easing from double digit peaks last year to 3-5 per cent annualised growth currently.
“However, with overall construction activity not expected to fall substantially, skills shortages persisting, geopolitical tensions rising, supply side shocks still in play – and a synchronised cycle of investment expected later this decade – there is a lot of uncertainty ahead for where construction prices go from here and a re-acceleration in construction costs cannot be ruled out,” said Hart.
About Oxford Economics Australia
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