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Economic and Financial Market Update: The Never Ending Story

06 August 2021

Summary:

The extent and length of the Sydney lockdown will result in a negative GDP outcome in the September quarter;
The outlook for the economy for 2022 and 2023 remains strong;
Availability of workers and materials will still be major economic issues next year;
The next move in the cash rate is up, but not until 2023.

The Sydney lockdown has lasted longer than most people had anticipated. In hindsight it should not have been a surprise. The Delta variant is substantially more contagious than previous versions. And it is impacting a population that was largely unvaccinated.

The impact of lockdowns will depend upon the length, spread and severity of Government restrictions, as well as how business and consumer confidence evolves. A measure of the stringency of restrictions is at its tightest level since the Melbourne lockdowns of last year. Consumer and business confidence has declined over the past couple of months, and is similar to what happened following the extended Melbourne lockdown last year. But the level of confidence is higher. The September quarter GDP growth will be around -2%.

The domestic and international evidence is that the shape of the economic recovery post lockdowns is a ‘V’. Households are sitting on a ‘mountain of saving’. Inventory levels are low. Firms need to invest as capacity utilization levels are high. Federal and state fiscal policy settings remain extremely supportive, as is monetary policy. The state government infrastructure pipeline is huge. Equity markets are near their highs. House prices continue to rise. The ‘V’ shape is seen in the profile of the recently updated RBA’s economic forecasts.

There will almost certainly be further virus ‘waves’ once high vaccination rates are achieved. Despite the proven effectiveness of the vaccines it is inevitable after the events of the past 18 months there will be initial political and consumer caution at the appearance of any further waves. This means there will likely be further government restrictions on economic activity in the event of a spike of new cases, albeit not as stringent as they currently are in Sydney. Consumer mobility would fall for a period.

The evidence points to a resumption of strong spending once the lockdowns end. The biggest constraint on the economy will then be supply. It will take the rest of this year before the large overseas developed economies are firing on all cylinders. It will take many Asian countries even longer. The shortages of materials that a growing number of firms have been complaining about will likely remain a problem for at least the next 1-2 years.

An even bigger issue is the lack of workers. Mainly that reflects the impact of the closed international borders. Federal Treasury assumes that international borders will only start to open up from mid next year, and then not be fully open until mid-2024. That assumption appears reasonable. This means that problems finding workers might be with us for another 2-3 years.

The RBA is rightly looking through the short-term weakness created by the lockdowns and forecasting a lower unemployment rate and stronger economy into 2022 and 2023. They acknowledge the short-term risks posed by the pandemic. And the potential for short-term pricing pressures. But the experience of COVID is that the easing of restrictions will be slower than anticipated and that the resultant supply problems will last longer. This suggests that interest rates will need to rise earlier than current RBA expectations of early 2024. I have the first move inked for mid-2023.