How the Australian economy will avoid a recession
Sydney Wealth Management | The information in this article is current as at 1 October 2022.
Part 1: Overview
The Australian economy grew by 3.9%1 over the year to 30 June, recording its strongest growth since 2012. Household spending grew by 6%1, benefitting from government stimulus measures, elevated savings and pent-up demand. Spending on travel, and services in particular accelerated as the economy reopened. Exports too benefited from sharp rises in the price of coal and liquefied natural gas (LNG)2 due to supply side shortages caused largely by the war in Ukraine.
Energy Prices3
Source: Bloomberg
Despite this underlying strength, the Australian economy is veering towards a critical inflection point. The pandemic induced global supply chain delays that caused sharp rises in the cost of everything from freight to semiconductors, has only been inflamed by the war, sending energy prices soaring. Given the importance of oil and gas as an input into household heating, transport costs and innumerable manufacturing processes, the flow on effects of these input price pressures have caused prices of many goods and services to rise generally. As a result, central banks around the world have had little choice but to lift interest rates to reduce demand to prevent inflation spiralling out of control.
Australia has not been immune to these events. In just 5 months, the Reserve Bank of Australia (RBA) has lifted the cash rate from 0.10% to 2.35%4. Further rises remain dependent on the trajectory of inflationary expectations, that in turn are a function of the main inputs: food, transportation costs, accommodation (rent) and wages. First, food price pressures in our view are likely to remain persistent due to elevated input costs (including fertilisers, transportation and a strong USD). Second, fuel prices have begun to decline in recent months on expectations of a slowdown in global growth, however, is likely to remain a headwind in the December quarter as fuel prices will rise from 1 October on the expiration of the 22.1 cent fuel excise hiatus. Third, landlords have been passing through the cost of higher interest rates to tenants in the form of higher rents, putting upward pressure on inflation. We expect the ability to pass through further rental hikes will diminish in 2023 as the economy slows. Fourth, despite unemployment near record lows, wages in Australia overall have confounded expectations and have generally grown well below the rate of inflation. As the supply of labour begins to improve again, with international students returning and the renewed issuance of migrant working visas, we expect this trend to continue and wage price pressures should gradually moderate in 2023.
Oil price – West Texas Intermediate (WTI) Futures (Sep-21 to Sep-22)5
Source: Bloomberg
The combination of these factors points to inflation potentially moderating after the December quarter. This view is broadly consistent with the RBA’s current projections. With inflation running at 6.1% at the end of June, the RBA now expects a peak of around 7.75%6 by year’s end, before gradually falling to just over 4% in 2023.
Opinions differ on where the official cash rate might peak, but the median forecast from a recent survey of economists predicts a high of 3.35%7 in Q1 2023. In contrast futures markets are currently predicting a peak of 4.3%8 in May 2023.
The large variance is due to divergent views on how rapidly the economy responds to the change in interest rates. It is estimated that households accumulated over $250 billion in savings during the pandemic. Pent up demand and the deployment of savings since the end of lockdowns has helped propel a robust recovery as well as give rise to a very strong labour market. This would support the view that the cash rate may have to be lifted materially higher (above 4%) to slow the underlying momentum in the economy and reduce price pressures.
On the other hand, Australia is a country with one of the highest levels of household debt in the world and so the average household is far more sensitive to rises in interest rates. This is illustrated by the Westpac Consumer Sentiment survey print in August which plummeted to 81.29, the lowest level since the deep recession experienced in the early 1990’s. This would support the alternate view that rates may not have to be lifted too much further to have the desired impact.
Westpac Melbourne Institute Index of Consumer Sentiment (3-month moving average, Sep-97 to Sep-22)
Source: Bloomberg
Conclusion
The latest internal credit card data from the Commonwealth Bank for the week ending 16 September10 shows that while household spending remains elevated, the rate of growth has begun to slow. We would expect this trend to gather speed in coming months as savings rates fall and households pare back spending in the wake of materially higher interest rates. This is likely to be exacerbated by the slowdown in global growth as well as falling asset values in both property and share markets, which typically have a deleterious impact on future spending intentions (often referred to as the negative wealth effect). As a result, we would expect growth to gradually slow in the December quarter and become more pronounced into 2023. At this stage the RBA is forecasting growth to slow meaningfully in 2023 to 1.75%11, but importantly, avoid a recession.
Household Debt to net disposable income12
Source: OECD
Part 2: Key economic indicators
| Economic snapshot | Last reported result | Date |
| Growth (GDP) | 3.60% | Jun-22 |
| Inflation | 6.10% | Jun-22 |
| Interest rates | 2.35% | Sep-22 |
| Unemployment Rate | 3.50% | Aug-22 |
| Composite PMI | 50.8 | Sep-22 |
| Economic snapshot | 2022e | 2023e |
| Growth (GDP) | 3.9% | 2.2% |
| Inflation | 6.3% | 4.4% |
| Interest rates | 3.2% | 3.2% |
| Unemployment Rate | 3.6% | 3.8% |
| US Dollars per 1 Australian Dollar ($) | 0.68 | 0.73 |
