Frank Uhlenbruch, Investment Strategist in the Australian Fixed Interest team, discusses the key events of 2021 and what to expect in the year ahead.
Did the Australian economy present any surprises over 2021?
The year began well with the economy re-opening and in ‘catch up’ mode following the lifting of earlier national and Victorian lockdowns. Economic growth was strong, and the labour market boomed with strong jobs gains and a sharp fall in the unemployment rate to 4.5%.
If there was a surprise for the global and domestic economy, it wasn’t from geo-political developments, but rather from the more transmissible Delta COVID-19 variant. From just after mid-year, localised offshore and domestic lockdowns took the wind out of the recovery’s sails.
In Australia’s case, lockdowns in New South Wales, Victoria and the ACT led to a sharp contraction in economic activity in the September quarter. Rising vaccination rates paved the way for a gradual re-opening of Australia’s Southeast mainland, allowing the economy to finish the year on a stronger footing.
There was also another surprise in store for investors and policy makers and that came from inflationary pressures which proved to be more persistent than expected. Strained supply chains, labour market turnover, energy shortages and higher energy prices have all added to higher headline and underlying inflation prints.
What’s in store for 2022?
A less bumpy ride as state-wide lockdown risk diminishes
As vaccination rates rise to 80% and above, the pace of recovery over 2022 should be less volatile than for 2021 given that New South Wales and Victoria have ended their state-wide lockdowns. That said, the recent emergence of the Omicron variant of COVID-19 has resulted in growing uncertainty as the year comes to a close. The threat from this new variant and its potential to affect the economic outlook remains to be seen. The high vaccination rates in NSW and Victoria mean they are not yet considering further lockdowns (at the time of writing), which should dampen the impact of this new virus strain on the economy.
After falling around 3% in the September quarter, we look for a rebound in the December quarter to deliver economic growth of around 1.75% over 2021. For 2022, we expect the economy to reach mid-2021 levels by around mid-year and grow by 5.25% over 2022. Growth is expected to ease back to 2.75% over 2023.
As the economy goes back into catch-up mode from late 2021, labour market conditions should rapidly improve. Labour supply is poised to improve as international borders gradually open up, but employers still face challenges in meeting the expectations of a post-pandemic workforce with its greater preference for offsite working.
Inflationary pressures should be most acute earlier in the year, but gradually ease as supply chains catch up to pent up goods demand. Nevertheless, the risk of cyclical price pressures finding their way into higher core inflation is higher than it has been for many years.
Monetary tightening coming, but unlikely in 2022
Towards the end of 2021 the Reserve Bank of Australia (RBA) abandoned its three-year government bond yield curve control target of 0.10% following an earlier than expected pick-up in the pace of underlying inflation. The move essentially re-linked cash rate moves back to developments in economic data, as was the case before the pandemic.
The barrier to near-term tightening remains high, with the RBA indicating that it expected no change to the 0.10% cash rate over 2022. Markets remained unconvinced, factoring in four tightenings or a cash rate just above 1% at one stage.
For the RBA to move, the following three hurdles will have to be cleared:
- The unemployment rate will have to fall close to 4%;
- Wages growth will have to lift to at least 3%; and,
- Actual inflation will need to be around 2.5% on a sustainable basis.
Our view is that these hurdles will not be cleared until mid-2023 when we expect the RBA to commence a tightening cycle that takes monetary conditions from a highly accommodative to a more neutral stance.