Until recent months, the Australian economy has confounded persistent reports of an impending economic slowdown. A combination of pent-up demand from months of lockdowns, supply side shortages and elevated savings levels have contributed to historically low unemployment rates that have helped sustain moderate growth. It was thought that high household debt levels would increase the sensitivity to rising interest rates and rapidly curtail growth, although in reality, the impacts have been much slower.
First, the massive fiscal stimulus unleashed during lockdowns helped to provide a savings buffer that has taken time to unwind. Second, asset price growth helped strengthen household balance sheets. Third, the pandemic has made many re-evaluate lifestyle priorities (“life is short”), which has helped sustain strength in hospitality and travel. Fourth, the distribution of home loans is uneven. Around 30% of the population have home loans of which about 40% are locked into fixed rate mortgages to take advantage of the low-rate environment that existed over the last few years. This cohort has yet to feel the impact of rising rates but will progressively do so as these terms mature. It has been estimated that over $370 billion of fixed loans will roll off over the next 12 months, at which time many borrowers will face repayments at least 50% higher. Given that savings levels have progressively unwound, and this will only accelerate as fixed loans roll off, a material slowdown in economic activity for 2023 is now inevitable.
Household Savings Ratio
This imminent slowdown view is validated by leading indicators including consumer sentiment, which remains near lows reached during the global financial crisis and in the NAB Monthly Business Survey, which saw business confidence turning negative for the first time since December 2021 as shown below.
NAB Monthly Business Survey – Confidence score (Nov-07 to Nov-22)
This comes at a challenging time as government coffers have been emptied by the generous handouts provided during COVID-19, leaving little room for further stimulus. Indeed, with gross government debt at over 37% of GDP and the budget in a structural deficit, the timing could hardly be worse. Interest payments alone on this debt are expected to exceed $18 billion5 this financial year. One of the most basic tenets of managing an economy is to save surplus tax revenues in the good years to provide a buffer for the additional expenses (unemployment benefits) in the bad years. But the good years have largely been squandered by successive governments focused on winning votes by introducing entirely laudable, but expensive social initiatives (e.g. aged care policies, NDIS, paid parental leave, etc) without long term funding solutions, and at the same time cutting taxes.
Australians face hard choices over the next decade as two of our major export earners, coal and natural gas, face intense headwinds as the world tries to limit further fossil fuel emissions. Coal exports this financial year alone are estimated to be worth around $120 billion, while LNG exports are forecast to be in the order of $90 billion6. Given the increasing frequency of devastating natural disasters in recent years, it is not a matter of if, but when, these carbon intensive fuels are phased out. At that time the federal and state governments will face major revenue shortfalls that can only be plugged by either slashing expenditure or raising taxes. Australia currently has one of the highest standards of living in the world, and this will soon be under jeopardy if the government does not come up with a credible plan to address this looming shortfall.
We expect the Australian economy to slow materially in 2023 to well below trend as the potent combination of an ailing global economy, persistent inflation, higher interest rates and falling asset prices (shares and property) conspires to erode purchasing power and crimp consumption. Lower demand, coupled with excess inventories, will make conditions challenging for many businesses leading to a slowdown in production and profits. At that point labour hours will be cut back and some workers will begin to be laid off, resulting in a gradual rise in unemployment.
ASX 30 Day Interbank Cash Rate Futures Implied Yield Curve
On the positive side, inflationary pressures are likely to gradually ease as demand cools. We would expect the cash rate to peak at 3.8%8 by May, allowing the RBA to then pause until the end of the 2023 when rates are likely to start coming back down in the face of materially weaker growth.
Part 2: Key economic indicators
|Economic snapshot||Last reported result||Date|
|US Dollars per 1 Australian Dollar ($)||0.65||0.7|