Much of the commentary around the current global economic outlook is negative and looking at the high-level inflation numbers and interest rate forecasts, this is understandable. However, a more insightful analysis of Australia’s economic prospects beyond the ‘eye of the storm’, paints a more optimistic picture.
At the Reserve Bank of Australia (RBA) board meeting on 5 July, the Board increased the Cash rate by half a percent (50 basis points) to 1.35 percent. The RBA Governor, Philip Lowe, observed that the increase is a necessary step in the withdrawal of the extraordinary monetary support that was put in place to insulate the Australian economy from the worst possible outcome of the Coronavirus pandemic. Governor Lowe went on to say that given the rising inflation rate and resilience of the Australian economy, this support is no longer justified. Governor Lowe added that the RBA Board is committed to doing whatever is necessary to bring inflation in Australia back to the 2-3 percent RBA target range next year. This statement implies that further rate rises are inevitable.
The RBA stated that global factors are at work in boosting the domestic inflation rate. These factors include COVID-related supply chain disruptions and the war on Ukraine. Both factors are pushing up input costs, including oil, gas, commodities and wheat. Other contributing factors are significantly higher household energy costs and high fuel prices. The widespread floods have further increased some food prices. The RBA said in its media release accompanying the July rate rise that inflation in Australia is lower compared with many other countries.
The RBA expects inflation to peak later in 2022, before declining toward the 2-3 percent range in 2023. The Statement issued by the RBA stated that inflation is expected to moderate in 2023 as global supply-side problems ease and commodity prices stabilise. The RBA went on to say that medium-term inflation expectations are well anchored, implying that inflation in Australia is under control and the RBA’s interest rate policy settings are appropriate.
This statement also infers that the likelihood of an economic recession in Australia is low. The Australian economy is being boosted by high commodity prices for its iron ore, coal, wheat, oil and gas exports, while unemployment at 3.9 percent, is the lowest rate in nearly 50 years. Job vacancies and job ads are at historically elevated levels, suggesting that unemployment could fall further in the coming months.
Looking ahead, market consensus is for another one and quarter percent increase, spread across 4 rate rises, comprising half a percent rise in August, followed by increases of a quarter of one percent in September, November, and February. If this were to occur, the Cash rate would be 2.35 percent by the end of the 2022 calendar year and 2.6 percent by February 2023.
Rising interest rates and an uncertain geopolitical environment are negative influences on investment markets. This negative outlook may continue throughout calendar year 2022 while the RBA is in the current interest rate tightening cycle. However, markets are forward looking, and it is not so much the state of the economy today that determines asset valuations, but the future state of the economy. This will become clearer after the August RBA board meeting which should signal smaller quarter of one percent rate adjustments ahead to calibrate the inflation rate to under 3 percent in 2023.
Emerging signs that inflation is trending toward the RBA 2-3 percent target range, will be positive for investment markets in Australia. This could occur late in 2022 or early 2023.
Uncertainty around the war on Ukraine may continue to weigh on investment markets, particularly given one of the parties is a superpower, with a nuclear capability. However, Australia being an export economy, has to date been a net beneficiary of the war on Ukraine, following the significant rise in prices for our major export commodities.
Overall, the Australian economy is in a superior position, relative to many other countries, to weather the economic challenges facing the world. This should mean that Australia avoids an economic recession and is one of the first countries to benefit from any global economic upside when it occurs.
This should be supportive of a favourable investment market going into 2023.