Cliff Notes: a volatile end to the year
Key insights from the week that was.
As is tradition in Australia, the Federal Government delivered its mid-year economic and fiscal outlook in the lead up to Christmas. As anticipated, this update highlighted a troubling combination of fading revenue windfalls and persistent strength in spending across critical services, infrastructure, cost-of-living measures and state/local grants. While 2024-25 saw a modest improvement in the budget position, future budget deficits and off-budget spending from 2025-26 through 2027-28 were revised up. Current circumstances and the outlook are consistent with a ‘two-speed’ economy, where the public sector drives growth as private demand remains weak, household spending and business investment continuing to be buffeted by tight policy and cost-of-living pressures.
The impetus for further strong growth in public demand is waning, however; and with headwinds for private sector demand only slowly abating, there is a risk of a ‘shaky handover’ of the growth baton from the government to the private sector. This theme is at the heart of our growth forecasts for 2025 and beyond, explored in detail at the national and state level in our latest Coast-to-Coast report.
Focusing on the consumer, the latest evidence from the Westpac-MI Consumer Sentiment survey continues to underscore a marked improvement in confidence through the second half of 2024. During October and November, consumer sentiment staged a rapid recovery from recession-era levels. While December saw a modest pull-back in the headline index (-2.0%), confidence in current conditions improved, particularly with respect to family finances versus a year ago (+6.9%) and whether now is a ‘good time to buy a major household item’ (4.8%). With the stage 3 tax cuts implemented and cost-of-living pressures slowly receding, a foundation for a pick-up in household consumption in Q4 and 2025 is forming, though only time will tell how strong it is.
Turning to New Zealand, the annual revisions to GDP were largely as anticipated, growth revised up through 2022 and 2023 such that, at March 2024, the economy was 2.3% larger than previously estimated. Unexpectedly though, Q2’s contraction was revised down from -0.2% to -1.1% and Q3 saw a further contraction of 1.0% against expectations for a 0.4% fall. In Q3, the decline in activity was spread across numerous sectors, the squeeze on consumers and businesses from the fight against inflation of particular note. However, some of the weakness stems from temporary factors too. Looking ahead, recovery is expected from Q4, Westpac’s GDP nowcast having moved into positive territory since October. Interest rate relief is providing a benefit, and there is more to come, our New Zealand team now expecting a low for this cycle of 3.25% after a 50bp cut in February and a 25bp reduction in April and May. This week also saw the release of the New Zealand Government’s half-year outlook. Much weaker than expected, the fiscal outlook also highlights the need for accommodative monetary policy.
Further afield, it was a strong finish to a big year thanks to three major central bank meetings.
The FOMC delivered another 25bp fed funds rate cut in December as expected, bringing cumulative easing since September to 100bps. That said, the tone of the statement was non-committal on the policy outlook, and the projections slowed the expected pace of easing. September’s 3.4% fed funds forecast for end-2025 is now not seen until end-2026. The FOMC continue to hold a favourable view of growth and the labour market and so, given persistence in inflation through 2024 and nascent risks related to the imposition of tariffs, are keen to bide their time with policy.
That said, it is evident from their forecasts that downside risks for growth are considered as material as those to the upside for inflation. We also believe it is important to keep a close watch on the risks. However, we anticipate downside activity risks are more probable in 2025 and upside risks for inflation from 2026. This leads us to hold an expectation of four cuts in 2025 against the FOMC’s two, but then two hikes in 2026 when they expect continued policy easing. We expect the inflation risks of 2026 to show persistence too, likely justifying a 10-year yield around 4.80% (along with growing fiscal uncertainty).
The Bank of Japan was the next cab off the rank, holding the policy rate at 0.25%, in line with our expectations. The statement indicated that accommodative policy alongside wages growth has supported inflation and above-potential GDP growth. The BoJ will continue monitoring whether businesses persist with robust wage increases and if that feeds through to prices. Union confederation RENGO has indicated they are aiming to negotiate a 5.0% increase in wages for FY25, with a focus on lifting wages amongst small businesses. This, alongside movements in the exchange rate were considered “more likely to affect prices”. Now that businesses feel more comfortable raising prices, future shocks to import prices, in part due to movements in the currency, are more likely to see consumer prices lift as well. A future move in policy will be predicated on whether RENGO can successfully negotiate a third consecutive strong wage increase and if higher import costs, possibly due to Trump’s policies, prompt businesses to raise prices. Evidence for this will be available in early March 2025, and the next rate increase should occur swiftly thereafter at the March 2025 policy meeting. The BoJ is likely to start winding back hawkish rhetoric after that and assess domestic and global conditions over an extended period before deciding if any further change in the policy stance is warranted.
Finally, the Bank of England met overnight and decided to keep the bank rate steady at 4.75% albeit with a bit of dissent – three out of six members voted to reduce it by 25bp. The labour market was considered ‘in balance’ but uncertainties remain around the outlook, partly a result of poor-quality data. While there has been progress on inflation since the start of the year, allowing the MPC to ease rates, concerns about inflation’s persistence are rising. More causes for uncertainty around disinflation were outlined, not limited to the expansionary measures announced in the Autumn budget and geopolitical tensions. These risks led most of the Committee to agree on a ‘gradual approach to reducing monetary policy’. From here, the Committee will want further evidence that the disinflationary pulse remains intact and that will come from signs that demand has eased to meet the constrained supply capacity. We expect the BoE will cut once per quarter in 2025 and end at a neutral rate of 3.50% by March 2026.
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