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The economy is slowing: Here's how we know

Composite image of a woman grocery shopping and Australian bank notes to signify economy.
Consumer sentiment is weak, which often leads to moderating household spending and, in turn, a slowing economy. (Source: Getty)

One critical element in getting inflation lower is dampening the pace of economic growth. It is a tried-and-true formula that has worked for many decades in the past.

Slower growth reduces the ability of businesses to increase selling prices and, as a result, businesses scale back the growth in production levels. This eases what are otherwise capacity problems, which in normal times feeds directly into business costs and, therefore, affects inflation.

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The seven interest rate hikes from the RBA since May and a tight Budget in October from the Government are directed at slowing growth and, with a lag, seeing inflation pressures ease.

The slowing in the global economy will also help to crimp inflation.

What evidence is there that the Australian economy is slowing?

The good news is that the policy tightening is starting to work.

Retail sales, in real terms, rose by just 0.2 per cent in the September quarter. This is a soft result after a burst in retail spending in the prior nine months.

At the same time, consumer sentiment is weak, which is usually a sign there will be more moderation in household spending growth.

The moderate fall in house prices, the crash in the bond market and broader weakness in share prices have seen household wealth decline, albeit from a high level. There is a strong link between changes in wealth and future household spending, which suggests there are looming downside risks to the household sector if house prices, in particular, remain soft.

The labour market data, which had been white hot, is showing signs of cooling. In the past three months, the level of employment has been dead flat, the fall in the unemployment rate has stalled at 3.5 per cent and, perhaps most importantly, there are clear turning points lower in job advertisements and vacancies, which if sustained, will see the labour market weaken in the months ahead.

Treasury and the RBA are forecasting the unemployment rate to increase to around 4.25-4.5 per cent over the next two years.

The October Budget was also tighter than most analysts were able to acknowledge.

Public demand, which incorporates the contribution of the government sector to the economy, is forecast to slow from 3.7 per cent through 2022, to -0.6 per cent through 2023, before a small pick-up to 1.4 per cent through 2024.

Unlike prior years, the government sector is helping to slow the economy and, with that, getting inflation lower.

Little chance of an Australian recession

There is further good news in the way the economy is evolving. There is a rebalancing of growth, which makes the chances of a recession extremely low given the buoyancy of the business sector.

Indeed, business investment is forecast to rise at around 5 per cent per annum over the next two years. This will add to capacity and see the business sector pick up some of the slack from the slowing in household spending.

Despite slower global economic growth, Australia’s export volumes are forecast to rise strongly right through to the end of 2024. Importantly, China’s economy is set to recover from the COVID lockdowns, which will provide something of an offset to the looming recessions in the US and Europe.

Bottom line GDP

All the data and forecasts point to a decent outlook for the economy. It is one where there is a necessary slowdown, but nothing like a recession.

GDP growth is forecast to ease from 2.9 per cent through 2022, to around 1.5 per cent per annum in the two years thereafter. It is a slowdown that will see the unemployment rate rise a little and, most importantly, inflation fall.

The forecasts for inflation are hotly contested. The RBA is forecasting inflation above 3 per cent, the top of its target band right through to the end of 2024.

This looks too high, especially if the economy is to register two straight years of 1.5 per cent GDP growth, with the unemployment rate edging above 4 per cent and the ending of supply chain problems.

The dip in commodity prices also points to an easing of price pressures in some areas.

In the end, the economy is slowing, as it had to do. This means the need for further interest rate rises is coming to an end as inflation eventually falls.

It is a good news story but one that will require close watching. No one wants a recession and Australia can avoid one. When the economy is already slowing, the case for a move to steady policy settings is getting strong.

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