The Australian economy has had a tough few years, but there are some reasons to be positive, and other reasons to be not so positive.
As 2024 draws to a close, a turbulent, torrid year in the Australian economy is at an end. But while many turn their attention to the festive season, they will do so keeping one eye on what 2025 has in store.
There’s a federal election, the return of Donald Trump to the White House, and the lingering cost of living concerns that continue to squeeze Australian households.
The future is uncertain, and that remains the case for the economic outlook for 2025. There is likely to be some good, some bad, and, unfortunately, a whole lot more uncertainty.
The good
While economic activity all but stalled in 2024, Australia did not experience the recession that some commentators had predicted. The weaker growth, however, was by design.
The Reserve Bank of Australia kept interest rates steady at 4.35% over the year as it tried to constrain demand to bring it more in line with supply, thereby helping to reduce inflationary pressures in the economy. As a result, inflation fell over 2024. This was also partly helped by various federal and state government cost of living measures, including energy rebates, which caused a significant reduction in the energy contribution to inflation in the latter part of the year.
There is still some way to go before inflation is sustainably within the RBA target band. Still, at its last interest rate meeting for the year, the RBA’s commentary had a more dovish tone than previously, suggesting that it might begin cutting interest rates as early as February 2025.
However, some market economists predict the Bank is more likely to start cutting rates later, probably sometime in June quarter 2025.
This will also be when the RBA will have a new board making decisions on monetary policy, as part of the reforms passed by the Federal Government in the final week of Parliament in 2024.
The labour market has held up much better than anyone thought possible in 2024, including the RBA. However, while everyone who wanted a job could reasonably find one, the income boost provided by the Stage 3 tax cuts, which came into effect in the second half of the year, have so far not resulted in the pickup in consumption that was anticipated.
It appears households initially decided to save these extra payments. However, the increased saving buffer will provide households with extra protection, and it is expected that in 2025, consumption growth will start to improve as households get more confident and income growth rises, which will provide a lift to economic growth, further supporting the labour market.
With the federal election likely to be held in the first half of next year, voters can expect to see both major parties promise more cost-of-living support to households. These measures, including a potential extension of energy rebates and enhanced access to childcare, will further support household incomes and consumption.
The bad
Unfortunately, there is unlikely to be significant relief for borrowers when the RBA does start to cut interest rates next year. Why? Because the RBA did not raise interest rates here as aggressively as its peers did, most notably the Reserve Bank of New Zealand, and Australians have not seen the same fall in inflation, either.
Further, the economy’s speed limit — that is, the pace at which it can grow without fanning inflation — is much lower now than it used to be. Persistently subdued productivity growth, or how efficient we are at using our workers and capital, is partly to blame, with the current level of productivity around what it was nearly a decade ago.
Analysis suggests that the weakness in productivity reflects sluggish growth in firms investing in capital, as well as not being as active in adopting new technological improvements.
One of the major contributors to people’s cost of living concerns in 2024 has been the cost of housing. Housing prices reached new highs during the year, and while modest declines are expected in 2025, it is unlikely to be enough to result in a noticeable improvement in housing affordability.
While the federal government passed some signature measures designed to help improve affordability, these are only likely to have a marginal impact on affordability. The only meaningful way to achieve long-lasting improvement in housing affordability is by significantly boost housing supply, which remains below the levels needed to meet demand.
An update on the Australian government’s fiscal position and outlook is set for March when the federal Treasurer Jim Chalmers hands down an early budget because of the impending election.
Chalmers has been the reason for much of the growth in economic activity in 2024, due to the public sector and with the government under pressure in the polls we could see a range of new expenditures announced.
When government revenue growth was supported by windfalls via high commodity prices, high income growth and record population growth as has been the case in recent times, this would have been no concern, but it is unlikely these windfalls will continue into next year and beyond.
As a result, budget deficits are expected to return in the next year and remain for the foreseeable future. A return to more sustainable fiscal outcomes will require a more disciplined fiscal strategy, at a time of mounting pressures from a range of challenges related to increased expenditure on the NDIS, medicare, aged care, climate change and defence.
The Uncertain
The new year will bring about a renewed period of heightened uncertainty driven primarily by global issues more so than local. At the centre of it all is the re-election of Donald Trump as US President and his stated intention to introduce tariffs on China and other countries. The concern is that this could inflame a trade war between the US and China, which would lead to a contraction in global economic activity and a surge in prices.
As one of the few countries with a trade deficit with the US, Australia is not expected to be directly targeted with new tariffs, but such a scenario could still be disastrous for Australia, a small, open economy with two-way trade accounting for just under 50% of GDP and China our largest trading partner.
However, recent comments from the RBA suggest that this gloomy scenario might not be so clear cut. Many of the details of the new tariff regime remain unknown, and the effects of a potential trade war on local economic activity and inflation are not certain.
Australia holds a comparative advantage in many of the goods it exports, such as iron ore and, increasingly, rare minerals, and these materials will be in demand for the foreseeable future. Further, the Australian dollar will no doubt act as a shock absorber to such events, as it has in the past.
So, while there is expected to be more uncertainty globally, locally the picture is a little rosier in 2025. Economic activity should pick up, supported by an improvement in household consumption.
The labour market should remain solid, and inflation could moderate a little more, allowing the RBA to provide some interest rate relief.
However, long-term, there are significant issues Australia will need to resolve including poor productivity, housing affordability issues and deteriorating fiscal position.
Dr Luke Hartigan is a lecturer in economics at The University of Sydney. He received his PhD in Economics from The University of New South Wales in 2017. His research interests relate to macro-econometrics, focusing on methods useful for the empirical analysis of business cycles and summarising and nowcasting economic and financial conditions. He also previously worked as an Economist at the RBA. Originally published under Creative Commons by 360info™.