Westpac Market Outlook September 2023
Our latest thinking on Australia, markets and the global economy.
Read full report 'Westpac Market Outlook September 2023' (PDF 824KB)
The peak in the interest rate tightening cycle now looks to be in, policy firmly on hold in Australia and the US and peaks imminent elsewhere. That should usher in a period of relative calm policy-wise, albeit with the full impact of tightening still flowing through to the real economy. For markets, attention is turning to the timing of and extent of prospective easing. This will naturally depend on, firstly, inflation developments, and beyond that, the growth profiles and degree of slack that emerges. Around inflation, progress has again been good, headline rates tracking towards targets in most economies. The news on growth has also been a little more positive than expected, especially in the US where the risk of recession now looks to be remote.
While returning inflation to target without damaging economic downturns would be a miraculous result given the scale of the inflation challenge and the degree of monetary tightening, it poses some challenges for central banks going forward. In particular, firmer than expected growth and tighter than expected labour markets will make it more difficult to achieve the ‘last leg’ of a sustained return to low inflation. It also means there will be both less scope – and less requirement for – policy easing. Reflecting these developments, we have significantly pared back our forecasts for the federal funds rate over the last month, with a much slower pace of policy easing now expected in 2024. Whether these same dynamics play out in Australia remains to be seen.
This shifting medium term profile also has implications for currencies, an improved interest rate spread set to be more supportive for the USD, delaying and dampening the expected lift in the AUD. Other factors are also in the mix, particularly the situation in China and uncertainty around both policy responses and knock-on effects for commodities. While we expect this to resolve favourably, noting that commentary on China underplays many significant strengths, this depends critically on ensuring support flows from strong to weak parts of its economy and that financial risks to do not get out of hand – achieving both outcomes will require timely and deft policy action.
Australia: A sharp slowdown of the Australian economy is underway, as confirmed by the June quarter national accounts. These show consumer spending broadly flat in the period, up only 0.1%, and the overall economy growing by a subdued 0.4%. Annual output growth is forecast to slow from 2.7% for 2022 to a well below trend 1.2% in 2023, marked up slightly from 1.0% previously reflecting an upward revision to the March quarter outcome. Household real disposable income contracted for a fifth consecutive quarter, despite current robust labour market conditions, squeezed by high inflation, rising interest rate payments and additional tax obligations. Conditions are likely to remain weak during the first half of 2024, as the labour market ultimately cools and unemployment rises. Then in the second half of 2024, the economy is forecast to strengthen to around a 2% annualised growth pace, supported by an emerging easing of both monetary and fiscal policy. On balance, we expect output growth of 1.6% for 2024.
Commodities: China’s headlines have been very negative with declining exports and property troubles sparking fears of a hit to resources demand. The uncertainty impacted base metal prices but iron ore and coal were unscathed, posting solid gains, and crude oil and LNG were slightly firmer on tight supply.
Global FX markets: The US dollar has recently gone against the down-trend established since September 2022. This has been the result of absolute and relative outperformance for GDP growth and despite a continued reduction in inflation and rate risks. We remain of the view that the US dollar will commence the next leg of its down-trend in coming months, with Asia to see the largest gains.
New Zealand: The economy is in a much-needed rebalancing phase with growth slowing to a below-trend pace. However, whilst off their peaks, pricing indicators still have some way to go before reaching levels consistent with inflation returning to the RBNZ’s target range. The outlook is subject to a number of uncertainties but we still think that the RBNZ will likely need to take further action if it is to bring inflation down quickly.
United States: The economy has recently shown strength, particularly around consumer spending and manufacturing investment. With rising household wealth and the labour market robust, even the small technical recession previously forecast seems improbable. Instead, 2024 and 2025 are now expected to see growth a bit below trend and inflation at or modestly-above target. In such an environment, prudent policy calls for the FOMC to maintain a restrictive stance, only slowly edging the fed funds rate down to be near neutral by end-2025.
China: Market headlines continue to highlight the West’s concern and apprehension over China’s outlook. While we remain impressed by the new economy’s growing capacity and vitality, these gains have to filter through to the rest of the economy as well if they are to underwrite the outlook. To allow this to occur, authorities must take an active role in the economy to buoy confidence and guarantee the proper functioning of the financial and public sectors. If authorities do not take action in coming months, their long-term ambitions will likely slip out of reach.
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