Are interest rate cuts on the horizon?

Following 300 basis points of interest rate rises from the RBA, the chief economist at Westpac is forecasting slower growth in 2023, culminating in lower inflation – and interest rate cuts.

Bill Evans’ report comes as the official cash rate increased by 25 basis points in December, marking the eighth straight rise this year. Coupled with rising interest rates, borrowers are still grappling with high inflation, which eased from an annual rate of 7.3% in September, to 6.9% in October. 

In a Westpac economic update released on December 9, Evans (pictured above) said he expected the first half of 2023 to benefit from the “spill over of momentum” in the second half of 2022.  Six-month annualised growth was expected at “around a 4% pace”, he said.

“We continue to forecast a slowdown in the growth profile for the Australian economy, from 2.6% in 2022, to 1% in 2023 and 2% in 2024,” Evans said. “ Household consumption is expected to fall from around 2% in the first half of 2023 (six-month annualised figure), to near zero in the second half, resulting in 1% growth over next year.”

Looking further into 2023, Evans cited a range of negative forces weighing on the household sector. These included a rising interest rate burden, the fading reopening of the economy, a higher savings rate compared to 2021 and 2022, a “damaging negative wealth effect” from falling house prices and negative real wages growth.

Business equipment investment was forecast to contract by around 7% in the second half of 2023, which Evans said was consistent with a depressing outlook for domestic sales and the expiry of tax allowances in June.  He expected the hit to activity to be compounded by a contraction in new residential investment, and in home renovation activity.

“A six-month period of a stagnant economy and no growth in household spending will alert the RBA to the need to ease policy settings in 2024,” Evans said.

In 2024, overall output growth was forecast to improve to 2%, with the bulk of the expansion (1.5%) expected to be in the second half of the 2024 year.

“Inflation will be lower in 2024 (at 3%) than the RBA’s current forecast of 3.25%, allowing the RBA to cut rates by around 100 basis points through that year,” Evans said.

He said 2023’s economic slowdown would be partly engineered by the need for the RBA to continue hiking the official cash rate in the first six months.  Wages growth and inflation were expected to remain “uncomfortably high”, and growth was expected to hold at a “respectable pace”, particularly in the first quarter, he said.

Upon releasing the national accounts on December 7, Treasurer Jim Chalmers said that households were “feeling the strain” of the combined impact of the global energy crisis, cost-of-living pressures and rising interest rates.

The household savings ratio fell for the fourth consecutive quarter, from 8.3% to 6.9%, while the national account measure of prices rose rapidly in the quarter, Chalmers said.

National accounts for the September 2022 quarter showed that GDP grew by 0.6% over the quarter, resulting in annual growth of 5.9%.

Evans said the latest national accounts were largely in line with Westpac’s expectations, and that he expected the themes identified in those accounts to extend through 2023. 

He said the risks for the economy were evenly balanced.

Westpac's themes for 2023:

• Inflation and wages may fall much more quickly than envisaged. This would allow the RBA to bring rate cuts forward and avoid the last hike (to 3.85%) Westpac is forecasting for May.
• Conversely, inflation throughout 2023 may be stickier than expected. This would mean the RBA holds off on rate cuts in 2024 as forecast, which Evans said would condemn the economy to another difficult year of weak growth – and no prospect of interest rate relief.
• Through 2023, Evans said it was important for businesses to embrace the difficult growth outlook and refrain from excessive price increases or outbidding competitors for scarce labour. The prospect of flat growth should convince businesses that large wage increases, and rising prices will be “unsustainable by the second half of 2023”, he said.

Evans said Westpac’s assessment was based on recent evidence of the evolution of the economy over the September quarter. This included:

• A slowdown in household spending growth, from 2.1% in the June quarter, to 1.1%
• A further fall in the household savings rate, from 8.3% in June to 6.9% (contributed to a portion of the lift in overall spending above)
• Household incomes are estimated to have lifted by $8.2bn (boosted by interest and dividend payments of $4.5bn) but were reduced by higher interest rate payments of $5.1bn.

Evans said household spending, boosted by a falling savings rate, continued to be the driver of growth largely thorough the reopening lift from travel, accommodation and hospitality, and motor vehicle purchases.

“As we move forward, the reopening effect will fade, property weakness will linger, the savings rate will find a floor and consumer spending growth will continue to slow,” he said.