Cost of living pressures, sharp interest rate hikes and a global economic downturn combined to signal a sharp slowdown in the Australian economy next year and consumer confidence at recession levels?
Economic and financial commentary may have been overly pessimistic lately, talking about a "grim," "bleak," and "dangerous" outlook. So some people think that a recession in Australia is inevitable next year, and rightly so.
However, Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP, has a different view and analysed the reasons why Australia should be able to avoid recession from seven perspectives.
1. The outlook for business investment is quite solid
According to data analysis, Australia's business investment plans remain strong in the year ahead.
ABS's Capital Expenditure Willingness Survey is up about 15% from a year ago.
This may partly reflect the rise in investment costs, but it is also consistent with high levels of capacity utilization, reasonable business conditions and confidence, and some easing of supply chain pressures.
Real business investment is expected to grow by around 5% in the coming year.
2. There is a lot of house construction work
The number of approvals for new homes in Australia is down around 25 per cent from last year's high, driven by the end of HomeBuilder subsidies and rising interest rates.
While this indicates a downturn in residential construction, it is likely to be buffered as there is still a significant amount of work yet to be done and home completions have not yet caught up with the surge in residential building approvals during COVID-19 (see areas circled in red in the table below).
This is mainly due to bad weather, shortages of labor and building materials. The large amount of work to be completed may provide a basis for residential construction and prevent a significant decline in residential investment, which is typically due to a 25% drop in the number of approvals.
Residential approvals and completions
3. High energy prices are raising national income
While the surge in energy prices has dealt a huge blow to household budgets, it has provided a huge boost to national income through revenues from energy companies.
This was evident in the strong trade surplus and resulted in a $48 billion increase in the budget deficit last fiscal year and a $42 billion reduction in the budget deficit this fiscal year.
This, in turn, helps reduce the budget deficit and provides greater fiscal flexibility for the Australian government.
4. If a global recession causes commodity prices to fall sharply, the Australian dollar will plummet
So far this year, the Australian dollar is down 11% against the dollar, but on a trade-weighted basis (i.e. the average exchange rate against other currencies) there is no change (as other currencies have fallen more against the dollar than the dollar).
However, if the collapse of global economic conditions causes Australian commodity prices to fall sharply, which in turn leads to a sharp decline in our export earnings (which would depress inflation globally and in Australia), then the Australian dollar could fall significantly.
This, in turn, will help support the Australian economy and make our exports more competitive, as they have done during the Asian crisis, the technological collapse and the global financial crisis.
5. Immigration is rebounding rapidly
Immigration levels rebounded as the backlog of entry visas was processed and data on net permanent and long-term arrivals per month showed a surge in the number of new arrivals. In line with this, the budget projects net migration for the current fiscal year at 23,500, in line with pre-COVID-19 pandemic levels. Prior to this, net migration in 2020-21 was negative.
The surge in immigration will help ease labor shortages and a tight job market, which is evident in the first two charts. That, in turn, will help stop wage growth from soaring well above inflation targets.
6. Inflation may not be a big problem in Australia
It's nice to say the economy is resilient, but that could just mean the RBA will have to raise interest rates more to slow demand enough to bring down inflation. In other words, previous considerations are necessary to avoid a recession, but not enough.
So this brings us to the issue of inflation, and we have reason to be optimistic that the RBA doesn't need to raise rates much further (money market assumes rates above 4%, but this will most likely push us into recession):
First, wage growth in Australia is much lower than in other countries;
Second, at least energy prices have not doubled or more, as they have in Europe;
Third, longer-term inflation expectations remain consistent with inflation targeting, which should make inflation easier to control than the high inflation of the 1980s when it was deeply entrenched;
Fourth, while the Australian labour market is very tight and there is a risk of wage blowouts, this is largely due to a lack of immigration. Unlike other countries, where labor force participation is higher than pre-pandemic levels, the return of migrants will alleviate worker shortages;
Fifth, simultaneous tightening of monetary policy by the central bank could lead to a sharp slowdown in global growth and inflationary pressures that Australia would benefit from, reducing the amount by which the RBA would need to tighten monetary policy;
Finally, upstream price pressures in the US are slowing and should benefit Australia as US inflation lags by six months.
7. RBA opts for the "slow lane"
Much will depend on how aggressively the RBA raises interest rates. The RBA has said it "will take the necessary measures" to bring inflation back to target. But others noted that it seeks to do so while "keeping the economy flat."
After an initial series of rapid rate hikes to return cash rates to more normal levels, the RBA slowed the pace of rate hikes to better assess the lagged impact of rate hikes, given the global economic downturn and hoping to "find the right balance between too much and too little".
In automotive parlance, it's "speeding to death" – an initial acceleration in interest rates is necessary to catch up with inflation, but if it continues to grow at this rate, serious accidents could occur that could lead to an unnecessary recession.