Deloitte Access Economics Business Outlook

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Deloitte Access Economics Business Outlook: can central banks thread the needle?

18 July 2022: A lot has changed in the last few months, and as a result, Deloitte Access Economics’ forecasts of the macroeconomic outlook have been downgraded – economic growth is expected to be slower, with inflation and interest rates now higher.

Releasing the June 2022 edition of the flagship Business Outlook report, Deloitte Access Economics Partner and report lead author, Stephen Smith, said: “The global and domestic economic outlook is clouded by uncertainty and volatility. Higher inflation, rising interest rates, falling house prices and weakening consumer confidence are testing the resilience of the recovery, just as a resurgent virus reminds us that it can’t be ignored.

Global economic conditions are softening. The United States is expected to avoid a significant recession. Whether a ‘technical recession’ of two quarters of negative growth occurs is largely irrelevant. What is important is that the US labour market remains robust, and that the Federal Reserve manages to avoid crashing the US economy by over-tightening interest rates over the next 12 months.

According to the report, US inflation could still correct at a more reasonable pace over the next 12 months than markets are fearing, despite a further upside surprise in the June data. “The cost of that correction will be paid in jobs and growth. But the weaker outlook means the Federal Reserve’s aggression on interest rates may fade as suddenly as it arrived, with the policy rate being lowered again as early as 2023,” Smith said.

“Widespread alarm is unhelpful, particularly when some of the global drivers of inflation are starting to subside. That includes a decline in the oil price, as well as continuing falls in the New York Federal Reserve’s global supply chain pressure index, which in June fell to its lowest level in more than 12 months. There is still a long way to go before global supply chains return to normal, but some unclogging of bottlenecks is a positive for the inflation outlook.”

Referencing the outlook in China and the easing of COVID restrictions in Shanghai and Beijing, Smith said: “The zero-COVID approach is still in place, the country’s unemployment rate remains high – particularly for young people – and consumer confidence has weakened. That combination suggests the Chinese economy will revert back to a slower pace of growth following the latest reopening rebound. As a result, we expect China’s economic growth will fall short of the official target of around 5.5% in 2022.

On the home front, Smith said: “The RBA surprised almost everyone with its relative hawkishness in response to the high inflation result in the March quarter. The fact that markets were surprised is not an issue – the RBA cannot (and should not) always meet the expectations of financial markets.

But the pace of recent interest rate hikes has raised questions about the previous guidance offered. As a result, the RBA now finds itself, unusually, an institution under a degree of pressure.

“Deloitte Access Economics agrees with most others that peak price growth in Australia is coming later in 2022, but that isn’t a certainty. Price growth – measured by the headline Consumer Price Index – is expected to peak at 6.6% in the second half of 2022, while interest rates set by the RBA may peak below 2.5% in the current cycle, well below current market expectations.

“However, any sign of further acceleration in price growth would see the RBA lift rates further and make the balance between fighting inflation and supporting economic growth more challenging. That would inch Australia closer to ‘stagflation’ – a central banker’s worst nightmare.

Setting interest rates in the current environment is more than a little tricky. Rising inflation is one thing, but it is also clear that growth is slowing. The post-pandemic high is fading quickly as house prices begin to turn downward and consumer confidence continues to slip.

Add in the darkening global outlook and it becomes quickly apparent that the risk of raising interest rates too much needs to be balanced against the risk of not raising them enough. It’s the job of central bankers to thread that particular needle right now, and the degree of difficulty could not be higher.

There is also some good news on the outlook, Smith said. “The opening of the border earlier this year has helped international migration to begin the long road to recovery and gives population growth a lift.

“Wage growth is also expected to trend higher more quickly than previously expected, though real wages will still be going backwards in the near term. Wage growth with a three in front of it is very reasonable, and any potential for wages to chase prices higher will ultimately be detrimental to workers in the long run.

“Fortunately, the potential for a wage-price spiral is limited – the labour market looks very different today than it did in the 1970s and 80s, with less coordinated wage setting and a less deliberate link between wage growth and inflation. If there are concerns about a wage-price spiral, the answer lies in a faster return to skilled migration and in boosting investment in order to drive higher productivity, allowing wages to increase without burdening the cost side of the equation.

Overall, Deloitte Access Economics expects economic growth of 3.0% in Australia in 2022-23 – a middle ground between continued recovery from the previous effects of the virus, and the dampening impact of uncertainty, rising interest rates, higher inflation and softer consumer confidence.

Industries

According to the report, the near term outlook by industry reflects the reversal of some of COVID’s most significant impacts on the likes of accommodation and food services, arts and recreation, and parts of transport, postal and warehousing, each of which took a substantial COVID hit.

The opening of borders and increasing levels of comfort in moving around in public will see further strong growth for these industries over the remainder of 2022 and into 2023. At the other end of the spectrum, industries which grew during the worst of the pandemic will give back some of those gains over the coming year. Agriculture, construction and manufacturing are the three sectors where output is expected to contract through 2022-23.

States and territories

New South Wales and Victoria have shaken off Delta lockdowns and the effects of Omicron over the last 12 months, though will need to spend the next year navigating a combination of rising interest rates and swollen mortgages.

Queensland is reaping the rewards of higher coal prices and attractive interstate migration figures, and Western Australia has been outperforming almost across the board. Both of those states – along with the Northern Territory – will be hoping commodity prices stay higher for longer.

Structural challenges look likely to again dog South Australia and Tasmania in the years ahead, while the ACT should benefit from a continued lift in the ranks of the public service.

Business Outlook is a quarterly publication presenting detailed economic forecasts and commentary to help understand the economic forces shaping the business environment. The forecasts cover a detailed assessment of the national economy, world growth prospects, each of Australia’s states and territories, and industries.

For further information (media):

Simon Rushton
Corporate Affairs & Communications
T: +61 2 9322 5562
M: +61 450 530 748
E: srushton@deloitte.com.au

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