The information in this article is current as at 2 January 2022.
Part 1: Overview
The Australian economy bounced back strongly to finish 2021. Consumer and business sentiment both remain elevated and above pre-pandemic levels while services such as hospitality are recovering as lockdowns ended. A new coronavirus variant, Omicron, poses some concerns but the positive, initial signs of vaccine effectiveness should limit severity and the need for excessive lockdown restrictions.
Growth
As expected, the Australian economy contracted for the September quarter by 1.9% due to the severe restrictions on businesses and households with lockdowns in NSW and Victoria over most of this period. However, government policy has helped support workers remaining attached to their employers via support programs such as the COVID-19 Disaster Payment offering a considerable measure of relief to households, more than offsetting losses from work in the June 2020 quarterly notably1.
Leading indicators of growth such as the Markit PMI surveys are showing signs of recovery. These surveys measure business activity across both manufacturing and services firms. In the latter case, the Services PMI was 55.7 in November (readings above 50 indicate the sector grew compared to the prior month), its strongest level since June2, just prior to the latest spell of lockdowns. We are also moving from a period where households have accumulated substantial assets with savings rates in the double digits since March 2020 as shown below. Consumer sentiment is also tracking at above-average levels which should support spending and overall growth in the months ahead3.
Inflation
The inflation backdrop domestically stands in sharp contrast to headlines in the US and elsewhere. While headline consumer price inflation (CPI) is tracking stronger at 3% for the year to September, it is well below levels seen elsewhere with “underlying” inflation tracking at 2.1% over the same period4. Key drivers of inflation in the near term have been rising energy prices (recovering from recessionary lows last year) and the impact of government subsidies, notably for housing (materials shortage) and childcare (unwind of subsidies by the Federal government last year)5.
A more frequent inflation indicator, the Australia Melbourne Institute Inflation Gauge, showed inflation of 3.1% for the year to November6. This is only slightly above the September result from the ABS (3%). A key driver of overall inflation is wage growth7. This rose 2.2% for the year to September. While a stronger pace, this remains below the 3% hurdle that the RBA suggested in July will likely need to be reached prior to hiking interest rates.
Monetary policy
The RBA moved in early November to end its yield curve control policy. The theory here was that by buying bonds in sufficient scale the RBA could keep short-term bond yields (up to 3 years) at a low level in line with its cash rate of 0.1%. However, a broad resurgence in inflation globally saw a sizeable uptick in short-term bond yields not just overseas but here in Australia, challenging the RBA stance. The RBA declined to defend its target prompting a sizeable sell off in bonds ahead of its 2nd November meeting. The broader question of RBA bond purchasing which remains underway at $4bn per week remains outstanding until a review scheduled for February next year. In the meantime, this adds support for the bond market (and bond prices) by keeping in place a price-indiscriminate buyer (the RBA).
Finally on interest rates, the RBA has only showed limited signs of moving away from its earlier calls for no rate hikes until “at least 2024”. One example is removing the reference to “at least 2024” from its monetary policy statements instead shifting to a more oblique “this is likely to take some time” (before conditions are adequate to support rate hikes). As noted above, inflation conditions are not yet sufficient to necessarily support market pricing (anticipating 0.75% in rate hikes by December 2022) unless growth exceeds expectations in the year ahead. On balance, hikes of this magnitude appear unlikely, particularly given current wage levels.
Labour market
The Australian labour market continues to recover from the damage inflicted by lockdowns earlier this year. The unemployment rate declined to 4.6% in November while the underemployment rate (a measure of people who want to work more hours than they currently do) also fell to 7.5%. Forward indicators for hiring are also positive. The NAB Monthly Business Survey highlighted improving business conditions as businesses looked to rehire staff in line with stronger economic activity. This, coupled with job vacancies hitting a 13-year high nationally, suggests strong demand for workers which should see employment pick up at a faster pace and overall unemployment decline in the months ahead. Eventually this should feed into higher wage growth as highlighted below. Wages typically pick up when the number of available workers (labour market slack) contracts because businesses need to pay more than before to hire new staff.
Coronavirus pandemic impact
Australia is gradually reopening with most interstate travel resuming, and Western Australia set to open its borders in early February8. Some restrictions on international travel were introduced to combat the spread of a new Omicron variant with entry from several southern African countries barred except for citizens and residents9. NSW has relaxed most mask mandates as of mid-December. Given the sizeable take up in vaccines and booster dose supplies secured, we should be better placed to handle any further waves without a sizeable increase in hospitalisations or deaths that has been the case elsewhere in the world. Initial studies also indicate the effectiveness of the existing vaccine regime in combating Omicron especially when coupled with booster doses10. Accordingly, we do not believe we will see a return to lockdowns of the scale seen in 2021 which will be positive for normalising economic activity.
Conclusion:
Overall, we believe the Australian economy will grow above trend (~2.7%) in 2022. External forecasts also corroborate this with the OECD anticipating 4.1% growth in real GDP for 202211 while some are even more optimistic with Westpac Economics for example anticipating 5.5% growth12. We also believe the RBA will be measured in raising interest rates in line with their current economic outlook which sees wage growth hitting the 3% threshold in late 2023 (suggesting lower likelihood of rate hikes in 2022).
Part 2: Key Economic Indicators
| Indicator | Last Reported Result | Comments |
| Growth (GDP)13 | -1.9% q/q Q3’21 3.9% y/y Q3’21 |
The Australian economy recorded its third largest contraction on record in the third quarter, though the fall was lower than expected. Growth was impacted by the lockdowns in the economic powerhouse states of New South Wales and Victoria. |
| 12-month Outlook | The economy is likely to regain its upward momentum in 2022 as lockdown measures diminish and economic policy settings remain favourable. | |
| Retail Trade14 | 4.9% m/m Oct’21 5.2% y/y Oct’21 |
Retail trade increased solidly in October as many lockdown measures ended but trade remains below levels recorded before the Delta outbreak. |
| 12-month Outlook | Retail sales are likely to gain traction in 2022 as restrictions are fully lifted and discretionary spending benefits from a stronger domestic economy. The Omicron variant poses a downside risk with the reopening of non-essential stores and hospitality businesses seeing rising case growth that should continue to be monitored. | |
| Manufacturing PMI15 | 54.8 Nov’21 51.6 Aug’21 |
The Australian Industry Group (AIG) stated that the Performance of Manufacturing Index (PMI) rose 4.4 points over the month and marks a solid result from the previous three months of relatively muted readings. |
| 12-month Outlook | The manufacturing sector should continue to strengthen as lockdowns diminish. | |
| Business Investment (Private New Capital Expenditure)14 | -2.2% q/q Q3’21 12.9% y/y Q3’21 |
Private new capital expenditure fell during the quarter but remains very strong on a yearly view. In particular, spending on equipment, plant and machinery increased 17.4% over the past year. |
| 12-month Outlook | The outlook for business investment is expected to continue to be supported by rising business confidence and a strong infrastructure pipeline. | |
| Unemployment14 | 4.5% Oct’21 | The unemployment rate increased 0.6% in October to its highest level in six months and would be far worse if the 333,000 who have given up looking for work were included in the employment statistics. |
| 12-month Outlook | We expect the unemployment rate to decline from current levels, though the speed will be dictated by the number of potential workers re-entering the labour force. Rising job vacancies are a positive near-term indicator suggesting stronger-than-average jobs growth in the months ahead. | |
| Inflation14 & Interest rates |
Inflation: 0.8% q/q Q3’21 3.0% y/y Q3’21 |
The Consumer Price Index (CPI) rose solidly for a fourth consecutive quarter, underpinned by a strong uplift in fuel prices and new dwelling purchase costs. |
| Interest Rates: 0.10% Cash Rate Dec’21 |
The RBA left the cash interest rate unchanged in December at a record low of 0.10%, although this is at odds with market expectations. | |
| 12-month Outlook | Inflation risks are likely to continue to build as policy settings remain accommodative and supply-side issues persist. They are not accelerating at the same pace as other economies such as the US, however, with wage growth remaining moderate. Notwithstanding this, the RBA is likely to retain the cash rate at the lower bound of 0.10% until at least late 2022, boosting the competitiveness of the export sector (by making the Australian dollar less attractive compared to other currencies). A risk to the interest rate outlook will be if economic activity is stronger than anticipated in the RBA outlook which may force the issue on rate hikes. | |
| Australian Dollar | AU$1 = US$0.72 | The Australian Dollar depreciated slightly over the quarter, down 0.2% (as at 29 December), with concerns over Chinese resource demand and the new Omicron variant outweighing an improving domestic economy following the lifting of lockdown restrictions. |
| 12-month Outlook | We expect the Australian dollar (AUD) to depreciate marginally over the next six to twelve months. First, US interest rates are anticipated to rise by more than Australian interest rates. This makes the AUD look less attractive for investors to hold, putting downward pressure on the AUD. Second, our China outlook suggests further slowing, implying less demand for our key resources such as iron ore, reducing demand for AUD. One factor that would support a more positive AUD outlook is a return to stronger China stimulus policies, but this remains uncertain. |
1 Australian Bureau of Statistics (ABS), Australian National Accounts: National income, Expenditure and Product, Economic Overview (accessed 13 December) : https://www.abs.gov.au/statistics/economy/national-accounts/australian-national-accounts-national-income-expenditure-and-product/latest-release#economic-overview
2 IHS Markit Australia November 2021 Services PMI (accessed 13 December): https://www.markiteconomics.com/Public/Home/PressRelease/84f70989f567400d939d5429c31446a7
3 Westpac-Melbourne Institute Index of Consumer Sentiment (as at 14 December 2021): https://www.westpac.com.au/content/dam/public/wbc/documents/pdf/aw/economics-research/er20211110BullConsumerSentiment.pdf
4 ABS, Consumer Price Index, Australia, Key statistics (accessed 14 December). https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/consumer-price-index-australia/latest-release
5 ABS, Consumer Price Index, Australia, Main contributors to change (accessed 14 December). https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/consumer-price-index-australia/latest-release
6 United States Census Bureau, https://www.census.gov/
7 Melbourne Institute Inflation Gauge month-on-month (accessed 13 December) https://tradingeconomics.com/australia/mi-inflation-gauge-mom
8 ABS, Wage Price Index, Australia, Key Statistics (accessed 14 December): https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/wage-price-index-australia/latest-release#key-statistics
9 ABC, WA border reopening: What will international and interstate travel look like?, 14 December 2021 (accessed 15 December) https://www.abc.net.au/news/2021-12-14/what-ill-travel-from-wa-look-like/100698722
10 Travel restrictions due to new COVID-19 variant (accessed 15 December 2021) https://www.smartraveller.gov.au/news-and-updates/travel-restrictions-due-new-covid-19-variant
11 ABC, Omicron COVID-19 variant: Experts say vaccine protection against severe disease remains high, but spread will continue (accessed 16 December 2021): https://www.abc.net.au/news/2021-12-15/omicron-variant-australia-covid-how-severe-vaccine-protection/100701012
12 OECD, Australia Economic Snapshot, Economic Forecast Summary – December 2021 (accessed 17 December 2021): https://www.oecd.org/economy/australia-economic-snapshot/
13 Westpac Institutional Bank, Westpac Market Outlook December 2021 & January 2022 (accessed 16 December 2021): https://westpaciq.westpac.com.au/wibiqauthoring/_uploads/file/Australia/2021/2021-12/WestpacMarketOutlookDecember2021-January2022.pdf
14 Australian Bureau of Statistics
15 Australian Industry Group, Performance of Manufacturing Index (PMI)
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