Economic update: 2024 in review and a 2025 preview
Key points
Goodbye 2024, hello 2025.
The domestic economic story of 2024 was not great. The jobs market was surprisingly strong, but economic growth was weak. Inflation declined but still ended the year too high. The cash rate was unchanged.
The 2025 economic chapter should take a turn for the better. Economic growth will be rosier, and inflation should decline further. The unemployment rate may rise, but not by much. That economic combination should be enough to see the cash rate come down, but only modestly so by historical standards.
| Q3 2024 (a) | Q4 2024 (f) | Q1 2025 (f) | Q2 2025 (f) | Q3 2025 (f) | Q4 2025 (f) | |
|---|---|---|---|---|---|---|
| GDP | 0.8% (0.9%) |
1.1% (0.9%) |
1.4% (1.2%) |
1.7% (1.6%) |
2.0% (1.8%) |
2.2% (2.0%) |
| Unemployment rate | 4.1% (4.1%) |
4.1% (4.1%) |
4.3% (4.5%) |
4.4% (4.5%) |
4.4% (4.5%) |
4.4% (4.5%) |
| Headline inflation | 2.9% (3.6%) |
2.6% (3.0%) |
2.4% (3.0%) |
2.1% (2.8%) |
2.8% (2.4%) |
2.9% (2.8%) |
| Underlying inflation | 3.5% | 3.4% | 3.1% | 2.9% | 2.7% | 2.6% |
| Cash rate | 4.35% (4.35%) |
4.35% (4.35%) |
4.35% (4.1%) |
4.1% (3.85%) |
3.85% (3.85%) |
3.85% (3.85%) |
GDP and CPI is annual % change. Unemployment rate is quarterly average. Cash rate is quarter end. Numbers in brackets are my mid-year forecast
GDP growth is set to improve in 2025.
The trajectory of economic growth in 2024 has been pretty much as I expected. The first half of the year was weak, reflecting the big decline in real household disposable income. Activity started to improve in the September quarter, as household incomes began to increase. The improvement in activity has so far been modest, as households have saved a fair chunk of their additional income. Household spending should grow stronger as consumers’ confidence continues to improve. There are signs of consumer spending ‘green shoots’ appearing in October and November.
The key question for next year is not whether the economy will be in a better shape, but how much better will that shape be.
Consumer spending and saving decisions will be key. There are signs that business confidence has been sapped by the extended period of weak consumer spending. One impact is that firms have marked down their capex spending plans for the remainder of this financial year. I expect that business confidence next year will improve as consumer spending rises. But there is the possibility of the business sector becoming a headwind to economic growth.
Government spending has been the main driver of economic growth this year. Despite a remarkable pickup in productivity growth, weaker growth in government spending will be required in a fully employed economy to create room for stronger private spending. But in a tight election year, a slowdown in government spending appears unlikely. Of course, fiscal support might be required if consumers keep saving or firms turn pessimistic.
I have modestly revised up my GDP growth expectations for next year on the back of the more expansive fiscal support from both the federal and state governments that has been evident this year. A weaker global economy is a risk to this positive view, particularly if the Chinese economy is unable to cope with higher tariffs. Population growth will still be strong by historical standards in 2025 although could be notably weaker the following year.
Unemployment rate: things are looking up
While I got my forecast of weak GDP growth this year right, I greatly underestimated the strength of the employment market. Strong government spending led to a substantial jump of employment in government and related sectors. And despite the weak economy, there has been a low level of retrenchments.
I still think that the unemployment rate is heading higher. Economic growth will likely remain sub-trend for the next 6-12 months. Over that time population growth is likely to be at an above historical average pace. At some stage there must be a slowdown in the public-sector jobs boom. The jobs market though has been stronger for longer than I expected. In recognition I have modestly revised down the expected peak of the unemployment rate in this cycle.
Inflation: forecast is looking positive.
Headline inflation has turned out to be well below my forecasts, largely attributed to government generosity in subsidising electricity bills and rent. I have also been (modetrately) surprised that ‘underlying’ inflation has not fallen by more, given the weakness of economic growth (and the decline of business and consumer inflation expectations).
All the signs are that ‘underlying’ inflation is heading lower. But the global experience (notably in the US) has been that ‘underlying’ inflation has proven sticky. In recognition of the inflation outcomes this year, I have revised down my headline inflation forecasts and (modestly) revised up my ‘underlying’ forecasts.
Cash rate: rate cuts not a matter of if, but when.
‘Underlying’ inflation was a bit higher than I expected and the unemployment rate a bit lower. Still my cash rate view of no change in 2024 has been right.
Given the jobs market has been stronger than I anticipated, I now think ‘underlying’ inflation will need to be in the twos before the RBA starts reducing the cash rate. It is possible that quarterly inflation might get there in the Q4 CPI (released 29 January) but, I think it more likely that we will need to wait until the Q1 data (released late April). For that reason I expect that the first rate cut to be at the May meeting.
The big negative for the economy in 2024 (weak household real disposable income growth) is turning positive, there is a large amount of investment spending needed to be done and heightened global uncertainty surrounding much of it surrounding the new Trump Presidency. As a result I expect the amount of rate cuts in this cycle to be limited by historical standards (half a percentage point).
Revisiting past predictions: the AUD / USD debate
I had anticipated that the $AUD/$US exchange rate would be now a lot closer to 70c.
My mistake has been less about being too optimistic about the $AUD, but being too pessimistic about the $US.
A higher cash rate meant I had anticipated that the US economic growth would be substantially weaker than what has turned out to be. The result has been that US interest rates have not fallen by as much as I had expected.
Revisiting past predictions: the housing market
I will talk more about house prices next month. In my forecasts at the start of the year I was far too optimistic about Melbourne, Hobart, Canberra, and Darwin standalone dwelling prices but far too pessimistic about Brisbane, Perth and Adelaide prices. I was a little low on Sydney. The end result is that my Australia-wider end-2024 forecast will end up being a couple of percentage points too low.
I suspect that 2025 will be a story of two halves. House price growth has slowed over the course of 2024 reflecting affordability concerns. This slowing momentum will probably carry over into a weak first half of 2025. But I expect a stronger second half helped by rate cuts, the general improvement of households’ disposable incomes and improved consumer confidence.
The modest amount of rate cuts means that the pickup in growth of house prices is likely to be modest. Perth is likely to again have the strongest market although I also expect a better year from the Melbourne, Hobart and Canberra. We shall see.
This is my final report for the year. Best season wishes to all. And hopefully my forecasts of a better economy in 2025 comes true.
We really do live in interesting times.
