Frank Uhlenbruch, Investment Strategist in the Janus Henderson Australian Fixed Interest team, discusses the key events for the Australian economy in 2020 and outlines what to expect in the year ahead.
Did the Australian economy present any surprises over 2020?
The year began on a slightly optimistic note geopolitically, with a reduction in trade tensions between the US and China and expectations for a solid year of global growth. Back home, the domestic economy felt the ravages of bushfires and its impact on people’s lives and livelihoods.
As we progressed through March, we suddenly became more aware of the magnitude of the COVID-19 pandemic which began as a local outbreak in Wuhan. The health policy response was to place the national economy into lockdown and provide unprecedented levels of fiscal and monetary policy support. Asset markets were understandably unsettled, with the equity market moving into bear territory.
By mid-year the Australian economy had experienced its largest downturn in nearly a century. While strong policy steps avoided an even worse outcome, the labour market weakened sharply, with a large fall in hours worked.
The economy began to regain some momentum from July post the earlier lifting of national lockdown measures. However, a renewed outbreak in Victoria, which saw Greater Melbourne locked down under Stage 4 restrictions from August to October, slowed the pace of the national recovery.
Our expectation is that the economy will finish the year gaining momentum, supported by fiscal easing in the October Federal Budget and monetary easing in November.
What’s in store for 2021?
Healing, but COVID-19 to leave an indelible mark
After falling sharply over 2020, we expect the Australian economy to rebound by around 5% over 2021. Large government transfers to households were saved mid-2020, with the household savings ratio climbing to an extraordinarily high 20%. Strengthening sentiment towards the end of the year suggests that the consumers’ mindset is shifting from ‘savings’ to ‘spending’ mode and this should underpin a vigorous rebound in consumption over 2021.
We also look for policy support to help drive positive contributions to growth from housing, business investment and public demand. Given the rundown in stocks and rebound in domestic demand, imports are expected to rise strongly and result in the external sector being a drag on overall growth over 2021.
While a 5% growth rate looks very high, we don’t expect the economy to reach end of 2019 levels until the first half of 2022. This means that the economy will have built up considerable slack and this will continue to show up in an elevated unemployment rate and inflation rate below the Reserve Bank of Australia’s (RBA) 2% to 3% target band.
Policy ready to give the economy a helping hand if needed
The economy has already received considerable stimulus, but both Federal and State governments have indicated they stand ready to provide more support to demand if needed. Likewise, the RBA has indicated that it can provide supplemental support to fiscal policy.
With the cash rate at 0.1% at the end of 2020 and the RBA reluctant to move into a negative rate regime, further easing, if needed, is likely to come in quantitative form. For example, the RBA could choose to increase the amount or extend the duration of its November 2020 program to buy government and semi government bonds to the tune of $100 billion over six months.
A key takeaway for investors is that the low risk-free interest rate regime will likely persist for at least the next couple of years and drive demand for income producing assets. The pre-conditions for a shift in accommodative policy is now ‘outcome’ based. Fiscal policy will move from accommodation to consolidation only when the unemployment falls below 6%. Monetary conditions will only normalise (first tightening in a new cycle) when actual inflation is sustainably in the 2% to 3% RBA target band and the labour market is at full employment. We do not see these outcomes being achieved over the next couple of years.