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Economic and Financial Market Update: When Supply Doesn't Meet Demand

20 August 2021

Summary:

The lockdowns have been more stringent, more widespread and lasted longer than most analysts have envisaged;
This means that Q3 GDP growth will likely be -3%;
A ‘technical recession’ (two quarters of negative growth) is possible, but unlikely;
The outlook for 2022 and 2023 remains strong, where supply will likely be a bigger issue than demand.

The overseas experience suggested that at some stage we would be confronted with another virus ‘wave’. Many countries in the OECD have been hit by at least 3 waves (and some are currently experiencing their fifth one). Developments in NSW (and increasingly Victoria) almost certainly indicate that the lockdowns will last longer than the end of this month. Evidence from across OECD countries is that ‘waves’ of the virus typically last for 2-5 months. Rising vaccination rates and more stringent restrictions on movement should help to break this wave.

The international experience suggests that at some stage new cases will rise again once restrictions are eased. Governments (and forecasters such as the RBA) have acknowledged that will likely result in periods of tightened restrictions, albeit nowhere near as stringent as they have been over the past 18 months. The recent US experience highlights that government intervention is not required for economic activity to hit a flat spot upon the appearance of another virus wave.

The Australian economy entered this lockdown in good shape. In the second quarter firms indicated that they had not seen business conditions as strong for over 25 years. Consumer confidence was strong, with households indicating that jobs were plentiful. The unemployment rate in July was 4.6%, the lowest level since 2008.

Things have got worse since the July employment report. And even the July jobs report showed some of the impact of the shutdown. There was a decline in the number of hours worked and in the participation rate. This was most notable in NSW, where there was also a fall in the number of employed.

At the start of the month the consensus range for Q3 GDP forecasts were in about a -1 to -3% range. Mobility data suggests that the size of the hit to the economy will be somewhere between what was experienced in the second and third quarters of last year. It looks increasingly likely that the outcome will be at the top end of the consensus range (and possibly higher). With restrictions in NSW likely to last at least into October, Q4 GDP will also take a hit.

I agree with the consensus that once Australia emerges from this wave the rebound of economic growth will be strong. Next year I think the main problem will not be a lack of demand but a lack of supply. Central banks are assuming that these problems are short term and will disappear as economies continue to re-open. That may well turn out to be correct. But producer price data indicates that there is still plenty of pricing pressure in the US economy. The longer that demand for workers remains strong in Australia and is not met by higher supply the greater the chance that wages growth will rise.