A cautious rate cut

It has been a long wait, but Australia finally has its first rate cut since November 2020. In line with market expectations, the closing monetary policy act of the ‘old’ RBA Board was to announce a 25bp cut to the cash rate target this week, taking it down to 4.1 per cent. The market – and media commentary – has adopted the somewhat oxymoronic description of a ‘hawkish cut’ to characterise the move. There is something to that description, but borrowing from the Board’s own statement, let’s go instead with a ‘cautious rate cut’, in line with Board’s comment that:

‘So, while today’s policy decision recognises the welcome progress on inflation, the Board remains cautious on prospects for further policy easing.’

As set out last week, the Board’s deliberations largely came down to balancing an acknowledgement that disinflation was proceeding somewhat faster than it had previously expected with its concern that the labour market simultaneously remained tighter than anticipated.

The presentational balancing act that followed saw Governor Bullock characterise the cut more in terms of an unwinding of the precautionary 25bp rate hike she had overseen back in November 2023 than as the start of a new cycle of policy easing. Indeed, such was the cautious tone of the central bank’s communications that some commentators (admittedly, skewed towards those sceptical of the case for a rate cut in the first place) are now speculating about whether this rate cut was ‘one and done’. While (eventually) that seems unlikely to be the case, a relatively slow and shallow loosening cycle does look to be on the cards, a turbulent world economy permitting.

It also follows that we remain very much in the RBA’s data-dependent world. In that context, the continued deceleration in wage growth reported in this week’s Wage Price Index release will have given the RBA some additional comfort that it made the right call on Tuesday. The subsequent Labour Force print will mostly have reminded it about those tight labour market conditions, even though the unemployment rate nudged slightly upwards.

More on the RBA and the latest data releases below, as well as the regular linkage roundup. This week also marks the return of the AICD’s Dismal Science podcast after an extended summer break. We talk about the RBA, DeepSeek’s ‘Sputnik’ moment for AI, and President Trump’s  almost-‘Smoot-Hawley’ moment for tariffs.

RBA cuts cash rate target

On 18 February the RBA Board announced it would cut the cash rate target by 25bp to 4.1 per cent. The decision concluded a run of nine consecutive meetings without a change, marked the first adjustment to rates since the November 2023 25bp rate hike and the first rate cut since November 2020, when a 15bp reduction took the cash rate target down to a record low of just 0.1 per cent.

As noted last week, the move was so widely anticipated by financial markets and RBA-watchers that a decision to remain on hold would have represented something of a shock. But we also argued that while the RBA would cut, the decision was a closer call than market pricing indicated. The messaging from Martin Place this week suggests this was indeed the case – in her press conference when responding to the opening question, the Governor said ‘it wasn’t a lay down misère…it was a difficult decision in the sense that there are arguments on both sides’.

Both the accompanying statement from the Board and the Governor in her remarks during her press conference framed the policy debate in much the same way as we set it out last week. The Board’s statement explained that the case for a cut was that inflation had fallen quite significantly from its peak in 2022. Moreover, the December quarter 2024 inflation reading suggested that inflationary pressures were now easing faster than the RBA’s forecasts had previously anticipated:

‘Some of the upside risks to inflation appear to have eased and there are signs that disinflation might be occurring a little more quickly than earlier expected.’

Additional support for the case for a rate cut was found in moderating wage pressures, abating housing cost inflation and reports from businesses that they were finding it hard to pass on cost increases to final prices. As result:

‘These factors give the Board more confidence that inflation is moving sustainably towards the midpoint of the 2–3 per cent target range.’

The case for caution, meanwhile, centred on the labour market, where the Board stated that:

‘…a range of indicators suggest that labour market conditions remain tight and, in fact, tightened a little further in late 2024.’

The net result of this assessment was a cautious rate cut. The RBA eased policy enough to recognise the progress made on disinflation, while leaving the cash rate in restrictive territory and warning that it would be in no hurry to deliver additional rate relief:

‘The forecasts published today suggest that, if monetary policy is eased too much too soon, disinflation could stall and inflation would settle above the midpoint of the target range. In removing a little of the policy restrictiveness in its decision today, the Board acknowledges that progress has been made but is cautious about the outlook.’

Thinking in threes: Messages from February 2025 Statement on Monetary Policy (SMP)

The February 2025 SMP that was published alongside this week’s rate decision delivered three key messages that support the RBA’s cautious positioning:

1. Underlying inflation (as measured by the trimmed mean) has continued to ease and has done so by a little more than the RBA had expected. The RBA now thinks it will reach the 2-3 per cent target range early this year – sooner than it had forecast in the November 2024 SMP.
2. At the same time, however, the labour market has remained strong. The RBA now thinks the unemployment rate will peak at just 4.2 per cent, rather than the 4.5 per cent peak it had anticipated back in November last year.
3. The outlook remains uncertain, with global developments (including but not limited to the Trump Tariffs) posing challenges to the international economic outlook and with risks around the RBA’s judgements on domestic conditions including the labour market, household consumption and productivity growth.

The updated forecasts in the February SMP are underpinned by three key judgements about the domestic economy:

1. Labour market conditions are not expected to ease much further. In this context Box C in the SMP looks at the substantial contribution of the health care industry to employment growth over the past year, accounting for more than half of overall employment growth over the year to Q3:2024. It concludes this has contributed to tighter labour market conditions in competing industries and overall.
2. Household consumption has started to recover, in line with a pickup in real household income. In this context, the SMP highlights a stronger-than-expected recovery in spending in the December quarter 2024, although it also cautions that ‘changing seasonal patterns driven by the increasing prevalence of discounting’ mean it is difficult to judge how sustained this will prove. Box B in the SMP takes a closer look at consumption and income post-pandemic, noting that (1) with real household disposable income per capita still around one per cent below pre-pandemic levels, the recent period has been among the weakest periods of real income growth since the 1960s. This has more than offset the impact on consumption of a 25 per cent increase in real wealth since the start of the pandemic; and (2) even after income per capita finally stabilised, consumption per capita continued to soften, perhaps reflecting an increase in precautionary saving.
3. Despite recent progress with disinflation, conditions in the labour market are expected to remain tight and on the assumed market path for the cash rate, this would contribute to keeping inflation a little above the midpoint of RBA’s target range.

On that third point, note that the SMP projections reflect an assumption that the cash rate will follow the trajectory forecast by financial markets. That would see the cash rate ending this year at around 3.6 per cent, before falling to around 3.4 per cent by the June quarter 2026 (for a total of around 90bp of easing). Given this assumption, underlying inflation remains at 2.7 per cent and above the mid-point of the target band through until the end of the forecast period. That means that by end-2026, underlying inflation is forecast to be higher than in the November 2024 SMP. But in her press conference, the Governor made it crystal clear that she thinks the market is over-confident on the likelihood of further rates cuts, stating:

‘…I want to be very clear that today’s decision does not imply that further rate cuts along the lines suggested by the market are coming.’

The SMP also highlighted three key risks to its central forecasts:

1. The RBA may have misjudged how much excess demand there is in the labour market. Put differently, it is possible that the economy is closer to (or even at?) full employment, relative to the central bank’s estimates. If so, inflation could fall faster than forecast without any further loosening in the labour market, although the SMP does note that its central forecasts for inflation and wage growth already include some downward adjustment to account for this.
2. The possibility of further intensification of global trade tensions represents a significant source of uncertainty for the domestic economy, with risks skewed to the downside for Australian activity, although the exchange rate is expected to serve as an effective shock absorber.
3. Weak productivity growth could prove to be more persistent than the RBA’s forecast assumes. The RBA’s baseline assumption is that labour productivity growth will return to around one per cent by the end of the forecast period, in line with longer run average annual rates. But over the five-year period pre-pandemic, annual labour productivity growth was much lower than that, at just 0.5 per cent. Lower productivity growth and the RBA’s wage forecasts would push up unit labour costs and threaten further progress with disinflation.

How low could they go?

Now that the RBA has delivered its first rate cut since 2020, attention has shifted from ‘when will the central bank start to cut rates’ to ‘how many rate cuts will there be, and how quickly will they come?’

The message from the Governor’s press conference this week and from  analysis in the February SMP is that Martin Place plans to proceed cautiously from here. The central bank also thinks financial markets are over-confident in their predictions of multiple rate cuts over the course of this year and next.

As noted above, one interpretation of this cautious stance is that the current rate cycle could be ‘one and done’. But – in the absence of a significant upward shock to inflation – that still seems unlikely. The RBA has been clear that at its current level the cash rate target remains in restrictive territory. Or to use central bank jargon, the actual rate remains above the neutral (nominal) rate. Under a base case scenario where the cash rate eventually returns to neutral, then, there remains scope for the RBA to do more, provided of course inflationary pressures continue to moderate. Guided by past RBA communications, a conservative estimate of the neutral nominal rate would be around 3.5 per cent, indicating that there could be room for two or three more rate cuts from here (also note in this context that the February SMP has a discussion of the neutral rate on page 10 that includes the observation that the RBA’s own models suggest a shift down in at least some estimates of neutral).

Still, while the neutral rate provides some guidance as to a possible terminal rate, that leaves an important question as to how long the RBA could take to get there. Here, the central bank is signalling that (again, absent significant shocks) it is unlikely to move quickly. The RBA’s ongoing concerns about labour market tightness and the potential risks that could imply for inflation mean that the path for easing is most likely to be a slow one from here, guided by upcoming data on inflation, activity and the labour market.

Wage growth slows in December quarter

Some good news for the RBA on this front is that this week’s wage data were consistent with the argument that the tight labour market on its own was sufficient to veto a rate cut. The December quarter 2024 Wage Price Index (WPI) rose 0.7 per cent over the quarter (seasonally adjusted) to be up 3.2 per cent over the year. That saw wage growth slow quite considerably from an (upwardly revised) 0.9 per cent quarter-on-quarter and 3.6 per cent year-on-year increases in the September quarter. The ABS said the December quarter quarterly increase was the lowest since the March quarter 2022, while the annual growth rate was the softest since the September quarter 2022.

In the November 2024 SMP, the RBA expected WPI growth to run at 3.4 per cent in the December quarter of last year, alongside a forecast for the unemployment rate of 4.3 per cent. Instead, both wage growth and the unemployment rate - which averaged four per cent - came in below the RBA’s expectations at that time (wage growth here is in line with the February SMP), taking us back to the point about estimating the amount of ‘true’ excess demand in the labour market.

Both private and public sector WPI growth eased last quarter. The private sector WPI rose 0.7 per cent over the December quarter and was up 3.3 per cent over the year, recording the lowest quarterly increase since the March quarter 2022 and the lowest annual rise since the June quarter of the same year. The ABS also noted that, compared to the December quarter 2023, there were declines in both the share of private sector jobs seeing a wage change (down from 16 per cent to 14 per cent) and in the size of the average hourly wage change (down from 4.4 per cent to 3.7 per cent – the lowest change since the March quarter 2022). It also highlighted that this was the smallest share of private sector jobs reporting a change in wages in a December quarter since 2019.

The public sector WPI was up 0.6 per cent quarter-on-quarter and 2.8 per cent year-on-year, with the annual rate of increase falling below three per cent for the first time since the March quarter 2023. The ABS pointed to the combined impact of the timing of some public sector wage agreements shifting to outside the December quarter in 2024, along with the expiry of some enterprise agreements and reductions in the size of wage increases paid under existing agreements. And again, when compared to the December quarter 2023 the Bureau highlighted significant declines in both the share of public sector jobs that received a wage change (down from 38 per cent to 23 per cent) and in the size of the average hourly wage change (down from 4.3 per cent to 3.3 per cent).

Finally, in terms of real wage growth, recall that headline annual CPI inflation was 2.4 per cent in the December quarter last year, so on that basis real wage growth was in positive territory. At the same time, however, the annual rate of increase in the Living Cost Index (LCI) for employee households was four per cent in the same quarter, implying that on this basis, living standards went backwards in real terms.

Both employment and unemployment rise in January

The signal provided to the RBA by the January 2025 Labour Force release was a bit more mixed than the message from the WPI. On the one hand, seasonally adjusted unemployment rate did tick up again last month. After having fallen to just 3.9 per cent in November last year, the unemployment rate has now climbed back to 4.1 per cent, rising by 0.1 percentage points from four per cent in December. That result was also in line with market expectations.

With the seasonally adjusted underemployment rate unchanged in January at six per cent, the overall underutilisation rate edged up from 10 per cent to 10.1 per cent.

On a trend basis, however, the unemployment rate remained unchanged from the previous month at four per cent. And the ABS also noted that some of the increase in unemployment in January reflected more people than usual with jobs who were waiting to start or return to work, implying that next month could see a decline in unemployment.

Moreover, employment rose by a strong 44,000 in January, well-ahead of the consensus forecast for a 20,000 gain. Full-time employment was up 54,100, but partly offset by a fall in part-time employment of 10,100.

At the same time, the participation rate rose to a new record high of 67.3 per cent, while the employment to population rate also set a new record, climbing to 64.6 per cent. The participation rate is now 1.8 percentage points above its pre-pandemic (March 2020) level and the employment to population ratio is 2.9 percentage points higher. The sustained increase in these two indicators is an underappreciated development in the Australian labour market post-pandemic, with the ABS highlighting the rise in female participation (up about 2.5 percentage points from 61 to 63.5 per cent) and employment to population (up almost three percentage points from 57.9 to 60.8) over the period.

What else happened on the Australian data front?

Average weekly ordinary time earnings for full-time adults (seasonally adjusted) rose 4.6 per cent over the year in November 2024, reaching $1,975.80 and equivalent to an extra $87/week. The annual growth rate was unchanged from May 2024. The ABS said growth over the six months to November 2024 was 2.7 per cent, up from the 1.8 per cent growth reported for the six months to May 2024. Average earnings growth was 4.8 per cent in the private sector and 3.4 per cent in the public sector. The Bureau noted that some of the strength in earnings growth over the past six months reflected compositional shifts, with robust growth in the number of higher paying jobs alongside a fall in lower paid roles.

The ABS said total wages and salaries paid by employers in December 2024 fell 0.7 per cent over the month to $102 billion. This was still up 5.7 per cent over the year, but down from annual growth of 7.3 per cent in December 2023.

The ANZ-Roy Morgan Consumer Confidence Index fell 1.6 points to a reading of 85.1 points in the week ending 16 February. On the eve of this week’s RBA rates decision, that result marked the lowest reading recorded so far this year. The fall was largely driven by declines in the two ‘financial conditions’ subindices (current and future conditions), which both dipped to a 2025 low. Weekly inflation expectations rose by 0.2 percentage points to 4.9 per cent.

The ABS published data on schools for 2024. According to the Bureau, last year 4.1 million students were enrolled in 9,653 schools. Of that total, 63.4 per cent were enrolled in government schools, 19.9 per cent in Catholic schools and 16.8 per cent in independent schools. Total enrolments were up 1.1 per cent over the year and 4.6 per cent higher over the five years to 2024. Over that five-year period, enrolments in independent schools were up 18.5 per cent, in Catholic schools by 6.6 per cent and in government schools by just one per cent. The Year 7/8 to 12 full-time apparent retention rate (which measures the number of secondary students who were enrolled in Year 12 in 2024, as a proportion of student enrolments from Year 7/8, five or four years prior) was 79.9 per cent, up 0.8 percentage points over the year. By type of school, the rate ranged from 96.6 per cent in independent schools to 81.6 per cent in Catholic schools and 74.1 per cent in government schools.

Last Friday, the ABS said short-term visitor arrivals in December 2024 were 945,280. That marked an increase of 7.8 per cent over December 2023. Total arrivals ran at 1,853,030, up 8.7 per cent over the same period.

Other things to note . . .

• The February 2025 edition of the RBA Chart pack.
• Will Australia’s GST fall foul of the United States’s proposed reciprocal tariffs?
• The Productivity Commission (PC) has produced a new research paper on Housing construction productivity. According to the PC, housing construction has suffered decades of poor productivity performance, to the extent that Australia is now completing half as many homes per hour worked as we did back in 1995. Labour productivity in construction has fallen by 12 per cent at the same time as labour productivity in the broader economy has risen by 49 per cent. The PC cites a complicated and slow approvals process, lack of innovation, a fragmented industry dominated by small players and difficulties in attracting and retaining workers as major productivity headwinds.
• This e61 Institute piece from Rose Khattar and Pelin Aykol on rethinking Australia’s demographic challenges argues that although migration has proven to be an ‘effective demographic management tool’ in the past, a decline in political support for high migration rates means policymakers may have to turn their attention to drivers of fertility rates.
• Alan Fels looks at the argument for adding a divestiture power to Australia’s Competition and Consumer Act, which would allow courts to break a firm into parts. The context relates to proposals to break up the major supermarkets, and more recently to break up insurance companies.
• Jenny Gordon on what Australia can learn from Bidenomics.
• The Parliamentary Budget Office (PBO)’s unlegislated measures tracker.
• The OECD’s Society at a Glance: Asia/Pacific 2025 focuses on fertility trends in the region. According to the report, total fertility rates (TFRs) remain over three children per woman in some countries in Central and South Asia and across less affluent Australasian Island nations. In India and Indonesia they are around replacement level (c.2.1), while in Australia and New Zealand they hover around 1.6‑7 children per woman and are lower still in Japan (1.3) China (1.2), Singapore (1.0) and Korea (0.8).
• Also from the OECD, States of Fragility 2025. According to the report, global fragility remains at near-record high levels. It analyses 177 ‘contexts’ (states, systems, and communities) and identifies 61 of these as experiencing high or extreme levels of fragility. These contexts are home to 25 per cent of the world's population or 2.1 billion people.
• In the WSJ, Douglas Irwin says the concept of ‘Reciprocal tariffs’ makes no sense.
• The Economist reckons Southeast Asia is drowning in a deluge of Chinese goods.
• The focus of the Munich Security Report 2025 is ‘the far-reaching consequences of the multipolarisation of the international order’ which the authors reckon combines ‘a shift in power towards a larger number of actors who have the ability to influence key global issues’ alongside ‘increasing polarisation both between and within many states’.
• In the FT, Robin Harding asks, who will stabilise the world economy now?
• Also from the FT, on Indonesia’s shrinking middle class.
• Some scepticism about generative AI (strong language warning).
• The Australia in the World podcast on the geopolitical loneliness of Australia. See also this column from the Economist.
• The These Times podcast discusses Trump, Putin and Europe’s Historic Crisis.
• Bloomberg’s Trumponomics podcast examines the US Treasury secretary’s uphill battle against America’s debt.
• Tyler Cowen in conversation with economic historian Greg Clark on social mobility over time.