The Path Ahead for Australia's Economy Intersects with Monetary Policy
Going into Q4 2024, several factors differentiate the state of the Australian economy from that of its peers such as Canada, Europe and the U.S. For starters, Australia’s short-term interest rate markets price far fewer rate cuts from the Reserve Bank of Australia (RBA) than other central banks, as priced by their respective interest rate markets. (Figure 1).
Figure 1: Markets price a slower pace of rate cuts from the RBA than other central banks
For example, as of September 25, traders’ pricing of SOFR and ESTR futures suggest the Federal Reserve (Fed) and European Central Bank (ECB) cutting rates by 175 basis points (bps) between now and the summer of 2026 (Figure 2). Moreover, all of these other central banks have already cut rates in recent months. By contrast, the RBA has thus far left policy on hold, and 90-Day Bank Bill futures price only about 75 bps of easing over the next two years (Figure 2).
Figure 2: The RBA didn’t raise rates as much as some of its peers and hasn’t yet cut rates
There appear to be two reasons why investors price fewer rate cuts in Australia than elsewhere. First, the RBA didn’t tighten policy as much as many of its peers. In 2022-23, it raised rates by 425 bps compared to over 500 bps in the U.S. or the U.K., and 475 bps in Canada.
The second reason is that Australia’s inflation rate has remained somewhat more persistent than in other countries. Inflation, excluding volatile items, stood at 3.5% YoY at the end of July, slightly higher than core inflation in the U.S. (3.2%), U.K. (3.3%) or the Eurozone (2.8%) (Figure 3). As such, Australia’s real interest rate (policy rate minus core inflation) remains somewhat lower than its peers (Figure 4).
Figure 3: Australia’s inflation rate has come down more slowly than that of other countries
Figure 4: Australia’s real interest rates are lower than elsewhere
Housing markets and the structure of the mortgage market explain why the RBA didn’t raise rates as much as in Europe or North America. In the U.S., Canada and parts of the Eurozone (notably France and Germany), people tend to use 15 to 30-year fixed rate mortgages. In Australia, mortgages typically reset after just three years. Moreover, many homeowners borrowed during the pandemic when 3Y mortgage rates were exceptionally low due to the RBA’s near zero short-term rates and yield curve control, which depressed bond yields further up the curve.
Those policies interacted with Australia’s high level of household debt, much of which is connected to the mortgage market. While Australia’s overall level of debt is lower than most of its peers thanks to modest levels of public sector and non-financial corporate debt, household debt is rather high at 109.7% of GDP (Figure 5). By not tightening as much as its peers, the RBA avoided excessively straining household balance sheets.
Figure 5: Household debt in Australia totals nearly 110% of GDP
That said, the RBA’s rate hikes have visibly slowed the Australian economy. The pace of GDP growth dwindled to 1% YoY by Q2 (Figure 6) and unemployment has begun to rise (Figure 7), albeit modestly thus far (Figure 7). If inflation continues to recede and if signs of economic weakness persists, investors might come to expect the RBA to deliver more and faster rate cuts than they price currently.
Figure 6: Australia’s GDP has slowed to 1% YoY growth
Figure 7: Australia’s unemployment rate has begun to rise
What is remarkable is that except for the exogenous shock of COVID, Australia has not experienced a recession as defined by negative GDP growth since the early 1990s. This is impressive given Australia’s dependence on commodity exports. Over the past three and a half decades there have been extended periods of depressed commodity prices including during the 1990s and the second half of the 2010s. Commodity prices have once again fallen sharply since peaking around Q2 2022.
Part of the reason why Australia avoided a boom-bust cycle is that it has been protected by a flexible exchange rate regime. When commodity prices were low during the1990s and early 2000s, AUDUSD fell as low as 0.48. When commodity prices peaked in 2011, an Australian dollar bought 1.11 USD. Over time, AUDUSD has roughly tracked an Australia-weighted commodity price index (Figure 8).
Figure 8: Commodity prices drive the AUDUSD exchange rate
The current level of AUDUSD at around 0.67 reflects depressed prices for many key exports including coal, iron ore and petroleum gas as well as other smaller exports like wheat, aluminium and copper. These prices are depressed mainly because of weak growth in China, which buys nearly 30% of Australia’s exports. Overall, exports amounted to 24.4% of Australian GDP, meaning that exports to China account for 7% of Australian GDP.
Over the summer, China’s economy appears to have slowed considerably more . Our past research suggests that the prices of many commodities lag the growth in China by roughly one year. As such, even If China’s economy begins to grow at a faster pace, commodity prices might not recover immediately and could fall further in the meantime.
The low level of AUDUSD might also explain some of the relative persistence of Australia’s inflation. On the one hand, weaker commodity prices lower inflation rates globally. On the other hand, lower commodity prices also mean a weaker AUD, which leads Australian consumers to pay higher prices for imports, offsetting some of the benefits for lower costs for raw materials prices.
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All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
