The information in this article is current as at 1 April 2022.
Part 1: Overview
The Australian economy is tracking at above-trend levels to start 2022. 2021 saw the economy grow by 4.2% according to the Australian Bureau of Statistics (ABS) compared against a trend (average) growth rate of 2.7%. We also see business surveys support the growth outlook. The Markit Composite PMI hit 56.6 in February (levels above 50 suggest expanding business activity) suggesting strength across both manufacturing and service sectors, the latter rebounding from Omicron disruptions in January. The NAB Monthly Business Survey echoes this with both business confidence and business conditions sitting above long-term averages. Capital spending intentions also improved, suggesting we will see more investment spending in the near-term, another positive contributor to economic growth.
This must be balanced however against a weaker outlook for consumer confidence. The Westpac-Melbourne Institute Index of Consumer Sentiment hit its weakest level since September 2020 with concerns over the Russian invasion, rising inflation and the impact of natural disasters all playing a part. This has potential to drag on consumer spending. Higher inflation also poses a headwind by diverting discretionary spending to essentials such as petrol and food. The recent Federal Budget has announced mitigating factors, such as halving of excise duties, which will shave 22.1c off fuel prices1, as well as enhanced tax offsets, which should support household incomes and consumer spending.
We see inflationary pressures persisting in Australia. The three main drivers at present are:
- Fuel costs – driven by surge in energy prices.
- Housing – mix of rising rents (housing rents rose 7.4% in 2021 according to the Domain Rental Report2) and higher costs for housing construction as the industry faces commodity shortfalls and a shortage of workers needed to address the backlog from the Commonwealth’s Homebuilder initiative.
- Wage growth – a tighter labour market (falling unemployment) means fewer surplus workers are available for businesses putting upward pressure on wages to attract and retain staff.
Importantly though, there are constraints on inflationary pressures here that are less evident in other countries. Wage growth in particular is not tracking as strongly as the US, with Australian wages growing only 2.3% for the year to December 20213. Given that a sizeable proportion of Australian workers still fall under Enterprise Bargaining Agreements, wages will be slower to adjust in aggregate to the tighter labour market as collective bargaining is a slower, more bureaucratic process. As a major energy commodity producer, we are less susceptible than other nations to the recent price shock. In Europe, for example, annual electricity price inflation (as measured by Eurostat) is running at 28.5% for the year to February 2022 compared to a 3% increase in 2021 for Australia4.
In summary, we see a stronger inflation outlook for Australia but at the same time we are lacking the acceleration seen in Europe or the US, so it should not present as severe a headwind to our economy.
The Reserve Bank of Australia (RBA) has taken a cautious approach to guiding on future rate hikes. As a reminder there are two facets to its guidance:
- That inflation is sustainably within the RBA’s target band of 2-3%, and
- That wage growth is at or above 3%.
On point one, the RBA can point to cost-push factors, such as the Russia-Ukraine war, as a sign that inflation is only temporarily, rather than sustainably, at target levels. On point two, wage growth is below this target and despite a tighter labour market, it will take time to converge.
That said, we have seen a shift in market expectations anticipating six hikes this year with a December 2022 cash rate of 1.6%. Consensus expectations amongst economists have also shifted higher with Westpac forecasting a 0.5% cash rate by year-end. The strength of the labour market (unemployment rate at 4% in February has already hit the RBA forecast for June 2022) and the inflation shock posed by the Russian invasion of Ukraine are now likely to see rate hikes this year. The earliest opportunity, we believe, would follow the Federal Election in May. We would suggest market pricing is too aggressive for Australia. It likely reflects two factors:
- Scepticism over RBA guidance given their mishandling and miscommunication in ending yield curve control (an emergency policy introduced in 2020) last year, and
- Pricing reflects overseas influences including the aggressive stance by the US, which impacts international bond markets and has raised funding costs for Australian banks.
We expect the RBA to hike in line with the economic consensus. A risk to that view is if we see inflation accelerate meaningfully. This could be due to the Russian conflict (and flow-on effects) lasting longer than we anticipate. On balance we see this as less likely and believe that the RBA will disappoint current market pricing in 2022.
Coronavirus pandemic impact
This remains a latent risk with new variants emerging. International experience suggests vaccine effectiveness will wane making subsequent booster doses necessary. Booster doses are important to limit the number of Australians requiring hospitalisation and/or intensive care due to coronavirus infection. As of 23 March, we have seen 61% of Australians aged 16 and above receive a booster dose. This compares favourably against other developed countries but is well below our initial vaccine program’s success. While State governments have moved to ease restrictions materially and Australian borders have reopened, we would caution that the emergence of a new coronavirus variant remains a potential risk to the economic outlook with the January experience (services sector activity slowing materially5) a reminder of this fact.
Australia has weathered the initial disruption of Omicron well with an above-trend growth outlook persisting despite the geopolitical shock of the Russian invasion of Ukraine. We do, however, believe a mix of weaker consumer sentiment, reduced fiscal and monetary support and inflation will act as growth headwinds relative to the 2021 experience. We expect the RBA to begin raising rates later this year with June the earliest likely timing. Despite this, a combination of strong household balance sheets and underlying economic momentum including tight labour markets, should see above-trend growth continue for 2022.
Part 2: Key economic indicators
|Indicator||Last reported result||Comments|
|Growth (GDP)6||3.4% q/q Q4’21
4.2% y/y Q4’21
|The Australian economy bounced back from its third largest contraction on record in the third quarter, with a 3.4% rise in the December quarter. The strong growth rate was aided by a further easing in restrictions across the country. Household spending was 6.3% higher during the quarter.|
|12-month outlook:||The economy is likely to continue to grow solidly throughout 2022 as restrictions continue to ease. Weaker consumer sentiment and interest rate rises (which are expected to be measured and remain very low by historical standards) are likely to temper growth outcomes.|
|Retail trade7||1.8% m/m Jan’22
6.4% y/y Jan’22
|Retail trade increased solidly in January as further lockdown measures eased, notwithstanding the emergence of the Omicron variant and rising COVID-19 case numbers.|
|12-month outlook:||Retail sales are likely to rise as restrictions continue to be lifted in light of falling Omicron cases.|
|Manufacturing PMI8||53.2 Feb’22
|The Australian Industry Group (AIG) stated that the Performance of Manufacturing Index (PMI) rose 4.8 points over the month and, after slipping sharply in January, once again indicates an expanding manufacturing sector.|
|12-month outlook:||The manufacturing sector should continue to strengthen as lockdowns diminish.|
|Business investment (Private New Capital Expenditure)7||1.1% q/q Q4’21
9.8% y/y Q4’21
|Private new capital expenditure rose during the quarter as solid investment in buildings and structures offset stagnant spending in equipment, plant and machinery.|
|12-month outlook:||The sound outlook for business investment is likely to be supported by rising business confidence and a strong infrastructure pipeline.|
|Unemployment7||4.0% Feb’22||The unemployment rate remained unchanged in January as 12,900 individuals were added to the workforce, but the rate would be far worse if the 333,000 who have given up looking for work were included in the employment statistics.|
|12-month outlook:||Over the remainder of the year the unemployment rate is likely to fall as rising job vacancies and a stronger economy auger well for job creation.|
|Inflation and interest rates7||Inflation:
1.3% q/q Q4’21
3.5% y/y Q4’21
|The Consumer Price Index (CPI) rose solidly in the fourth quarter, underpinned by significant price rises for new-dwelling purchases and automotive fuel.|
0.10% Cash Rate
|The RBA left the cash interest rate unchanged in March at a record low of 0.10%, as the bank monitors the economic fallout from Russia’s invasion of Ukraine.|
|12-month outlook:||Inflation risks are likely to continue to increase as a result of supply-side bottlenecks, continued rises in input costs, most notably in fuel price, as a result of the war, and a tighter labour market. This is likely to lead to inflation readings persistently above the RBA’s upper bound over 2022 and potentially lead to the RBA raising rates after the Federal election in May.|
|Australian Dollar||AU$1 = US$0.75||The Australian Dollar has appreciated moderately over the quarter. Commodity prices have risen across the board in 2022 and have spiked higher since Russia’s invasion of Ukraine, on supply-side concerns. In particular, the iron price has rebounded strongly in 2022, aided by stimulus measures by Chinese Authorities as they deal with burgeoning COVID-19 cases in several large cities, as well as the continued lifting of lockdown restrictions.|
|12-month outlook:||We expect the Australian dollar (AUD) to remain well supported because of the strong near-term outlook for commodity prices. This will be partly offset by a likely moderation in the global economy and by higher relative interest rates in the United States. This would suggest the AUD should trade in a fairly narrow range (US$0.70- US$0.78) over the forecast period.|