Inflation, interest rates and the economy in 2022 and beyond

Banjo had the privilege of hosting Alan Oster, Group Chief Economist at National Australia Bank (NAB) on our recent webinar, where he shared his global and Australian macroeconomic outlook.  Here’s a brief extract of his comments.

The global economy is slowing in 2022.  If it continues to slow throughout 2023, we can expect the main impact in 2024.  

The three main regions of concern are: China, Europe and Japan.  China’s issues with Omicron, and the associated recent shutdown in Shanghai have had major impact.  There have been falls in the Chinese data, retail sales are down 14%, and their central bank has cut rates and added extra liquidity. 

The Russia/Ukraine war has of course fuelled concerns about Europe.  Commodity prices are currently very high.  If Europe and the G7 countries ban Russian oil, to which the Russian economy is very exposed, Russia may cut off gas supplies in the northern winter, which would cause major disruption in Europe at the end of 2022 and into 2023.

Japan’s growth is going backwards at the moment, and only weak growth of around 1.5% is expected later in 2022 and beyond.    

Compare this to Australia, where despite a weak start to the year due to Omicron and the floods, there’s been a big acceleration in growth since COVID restrictions phased out.  For example, by the end of May hospitality (about one third of the Australian economy) was shooting the lights out – the strongest Alan’s team has ever seen this sector.    

NAB analyses data from its 5 million transactions per day, including consumer and business clients. On weekly business inflows, mining and agriculture were the strong performers last year.  This year construction, manufacturing and transport are leading the surge, although mining continues to be strong.  Given the seasonally adjusted data, retail is meeting the pre-COVID (2019) benchmarks but is still not where it should be.

NAB’s data shows that SMEs are doing well compared to the 2019 benchmark.    

However, health and education are still struggling.  Elective surgery has been slow to pick up, partly due to staffing issues.  In education students are coming back, but not yet in big enough numbers, so the sector is well behind the 2019 benchmark.

In terms of business conditions and confidence, transport and construction are starting to flatten out.  The construction sector is still optimistic, but Alan flagged problems on the horizon.  This centres around fixed price contracts, which are proving to be problematic now that purchase costs are going up.  

Increases in construction, transport, and manufacturing costs are running at around 5% per quarter, with flow-on effects to inflation.

Unfortunately, inflation is going to be around for a while.  Alan uses the core inflation figure (as opposed to the headline number we usually read about), currently around 3.8%.  He expects this to rise to around 4.5% and stay there for a while.

Where interest rates are concerned, the NAB team predict interest rate rises in June, July, August and November, and expect the cash rate to reach 2.1% by late 2022, then to peak at 2.6% in 2024.

Alan points out that monetary policy takes about 12-18 months to have its impact.  “Monetary policy is like a piece of elastic with a rock attached.  You pull the elastic, and nothing happens, you keep pulling and then all of a sudden you get a black eye!  So it has to be handled very carefully.”  

House prices in Sydney and Melbourne have seen a big slowdown, and Brisbane is also starting to slow.  There are still strong bank approvals for housing, which is driven by owner occupiers just now.  Alan expects that house prices will go down 10% overall, but in the context of the 22% rise over the last couple of years, it’s certainly not catastrophic.  Eighty per cent of the home loans in Australia are variable, and on average, homeowners are 4 years in advance on their home loans, so they can broadly handle rate increases.  However, some may panic, which will influence behaviour.

Alan points out that household savings are concentrated at the top end of income distribution.  The middle-income group are essentially spending what they earn, so the cost of living is set to become a big issue in Australia, with consumer cash flow (and therefore spending) potentially drying up in about 6 months.

Unemployment will continue to fall to 3.5% and stay there till early next year, when it could rise to 4%.  Australian wage growth has been below expectations for some time, but the national wage case is likely to pick up soon.  

The number one lesson from the pandemic is: don’t have all your supply chain eggs in one basket.  If you haven’t already, start to diversify your supply chain.  India, Japan and Korea are good sources.  Australia should also be strengthening its own manufacturing.  

Overall, Alan is optimistic about the economy.  The damage to our economy, and the death rate from COVID was considerably lower than other countries, so even with higher interest rates and slower global growth, the outlook for Australia is comparatively good.

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