Australia Economic Outlook Q1 2025

Expect a slow easing cycle

The Reserve Bank of Australia (RBA) kept the official cash rate unchanged at 4.35% in Q424, as we had expected. Our base case remains for the RBA to commence easing in early 2025 at either the February or April meetings depending on how the data evolves over the next few months. Increasing our confidence is the shift to a more dovish stance by the RBA. When the easing cycle here commences, we think the cash rate could converge to 3.60% by the end of 2025.

The recent softening in tone and dialling down of rhetoric by the RBA suggests to us they have become more confident that core inflation remains on track to fall in line with their projections. Headline inflation is running at 2.8% YoY, while trimmed mean is 3.5% YoY¹. Subsidy effects have delivered a significant and temporary headline disinflation impulse. With a federal election due by May 25, there is a high probability the subsidies will be again extended which will keep headline inflation low. Although the RBA forecasts don’t see core inflation at the midpoint of the 2-3% target band until 2026, the Board doesn’t need to wait to cut rates if they think inflation is “sustainably” falling.

We noted last quarter that labour market conditions were important for the RBA in choosing when to ease policy. While this remains true, very sluggish GDP growth has become an increasing worry for the bank. The RBA acknowledges the labour market is tight and is outperforming versus their expectations. With a current jobless rate of 3.9%, just 0.5% above the post-Covid low of 3.4% (October 2022)¹, the risks of a rapid deterioration in labour market conditions has diminished considerably. The RBA expects only a small pick-up in the unemployment rate to 4.4% by Dec-2025².

Consumer sentiment is still weak, but we expect conditions to improve moderately through 2025. House prices in the major capital cities are expected to remain under pressure in the short-term, however, rate cuts in 2025 should help to improve affordability metrics. Investment in the housing sector will increase, with the government's ambitious housing target of 1.2 million³ dwellings over five years underpinning supply. Wage price growth is slowing, with the RBA's preferred wage measure – the Wage Price Index (excluding bonus) - running at 3.5% YoY¹, the slowest since 2022. The very weak pace of productivity growth remains a challenge for the RBA and limits the degree to which monetary policy can be eased in 2025.

The new structure of the RBA Board becomes effective from 1 March 2025 and based on the membership of the interest rate setting committee, we’d expect to see a smooth transition with respect to their decision-making processes. On the fiscal side, with a federal election in 2025 (by 17 May at the latest), it is expected the government will bring down an early 2025-26 Federal Budget around March. As things stand, the deficit starting point of ~1% of GDP will be a "bit weaker" than previously forecast. With cash deficits baked in over the forecast horizon, there will be increased issuance of government bonds in 2025.

While there remains some uncertainty around what a Trump administration might do with regards to tariffs, recent announcements in China by the Politburo to counter some economic fears are moderately positive for the Australian economy. Chinese policy makers have vowed to embrace a “moderately loose” monetary policy in 2025, and pledged “more proactive” fiscal policy, signalling more rate cuts ahead and shifting from a “prudent” strategy that’s held for nearly 14 years. The RBA has suggested that if China is impacted negatively by tariffs, that could create local disinflationary forces, as it attempts to shift some if its exports to other markets, including Australia.

The first full 25bp rate cut has been priced in for April 25 by the market, with a >50% chance of a 25bp cut priced in as early as February. We think that’s fair pricing given the recent change in tone by the RBA. The implied terminal rate is around 3.60% by the end of 2025, which is close to the RBA’s estimated neutral rate level. We would expect an easing cycle to be a slow and drawn-out affair as the RBA opts against pre-committing to any particular easing path.

Services Inflation is expected to remain sticky

Overweight on Australian credit

Credit again performed well in Q4 capping off a strong year for returns in the local IG corporate market. Despite some periods of spread volatility driven by offshore events, the general “risk-on” tone provided by strong equity markets, soft economic landings, global central bank easing and minimal credit defaults, all proved to be a powerful force for spread compression.

The corporate market continued to benefit from meaningful fund inflows from offshore investors, particularly Asian investors. Inflows have been the overriding narrative and demonstrate how “following the money” has been an important factor to consider when positioning credit exposures. Inflows have also supported new issuers accessing the domestic primary market in a sizeable way helping to diversify portfolios. We expect this trend to continue given the relative attractiveness of domestic ‘all-in’ market yields.

From a fundamental standpoint, companies have made good progress in pushing out maturities, which has eased near-term liquidity pressures and provides some cushion if market volatility arises and/or investors become more risk averse. Estimates of supply for 2025 look very manageable for the local market to take down.

After two years of spread tightening, we believe Australian credit spreads are likely to trade sideways in 2025. We remain overweight credit as investors can continue to pick up ‘carry’ in a relatively benign macro environment. We note that U.S. IG and HY spreads are very tight and further compression, while feasible, is likely to be a slow grind. For global investors, the Australian corporate market continues to offer a lower beta and low duration versus the major U.S. and EUR credit markets. For Asian investors a spread pick-up also remains on offer.

We remain alert to periods of market volatility centred around deepening geopolitical rifts and Donald Trump’s return to the White House in January. The outcome of each could have wide-ranging market ramifications.

Australian Credit Spreads

AUD performance impacted

After reaching a high of US$0.6910 cents on October 1, it was all downhill for the AUD in Q4, culminating in a breakdown below US$0.6300⁴ cents in late December. The decline followed the Fed’s decision to signal a slower pace in their 2025 easing cycle and a higher terminal rate. A perceived more hawkish Fed saw USD demand against anything and everything and the DXY poised to close at YTD highs. Relative US growth outperformance in 2025 and a reluctant Fed (and higher US yields) could further strengthen flows into USD.

While the initial reaction of the AUD to China’s stimulus measures in Q324 was positive, the market enthusiasm around what this actually delivered for the Chinese economy faded during Q4. China's economic performance has been muted which has had an adverse impact on the AUD. To help reverse this trend, a significant step up in China’s economic stimulus to boost consumption and housing will be required in 2025.

With all indications that the new Trump administration wants to hit the ground running on key strategic priorities - tax cuts, tariffs and supply-led oil price declines, this has the potential to be a challenging combination for the AUD. Coupled with a slight dovish RBA recalibration, it’s difficult to see the AUD above US$0.6500 cents in Q1.

AUD / USD