Economic Update: Looking ahead to 2022

If you can imagine the economy as a road, 2020 saw a major earthquake emerge with the Coronavirus pandemic, and the lockdown restrictions that followed to halt its spread, and the Government and RBA support helping to divert traffic around this major obstacle. 2021 will be a year of bouncing back and looking forward to the economic recovery, with rebuilding and a gradual resumption of normal activity. However, the world in many ways has now changed.

Coronavirus pandemic and solutions on offer?

The Coronavirus pandemic remains a concern with cases and fatalities in new waves particularly in India, Brazil and, to a lesser extent, continental Europe. We have seen a response in the creation of new vaccines at an unprecedented speed. This has had its drawbacks with both AstraZeneca and Johnson & Johnson vaccines under a cloud of scrutiny over blood clot side effects which has seen their use suspended, or curtailed considerably, in countries such as Australia. This leaves the Pfizer and Moderna vaccines as the flagships globally with Australia one of many looking to follow this path.

It is likely we will have to wait until 2022 for a sufficient proportion of Australians to be vaccinated and “herd immunity” reached. This means that hotel quarantine failures and snap lockdowns will continue lurking as a potential risk over the next two years.

Jobs market

The improvement in the jobs market has been pronounced, with Government support, such as JobKeeper, playing an important role in stabilising business finances, along with Australia’s relative success in keeping the pandemic contained.

Looking forward, we have a picture of strong and improving business confidence and rising job vacancies. These should continue to drive jobs growth over the next year which will not be without it’s challenges, however. Closed borders impact the tourism and education sectors substantially and, given the current pandemic and vaccinations trends, a return to normality is unlikely until next year – at a minimum.

Property market

The property market has bounced back quicker than many expected. A key driver has been ample demand for borrowing by households with banks showing a willingness to supply, even increasing their exposure to riskier loans. Absent regulatory intervention to limit bank lending (as happened over 2017-19) the near-term trajectory of credit growth (which leads price growth) suggests that property prices will continue climbing over 2021.

The Budget and Government debt

2021 will be a year of consolidation for the Government. The big-ticket spending items such as JobKeeper have now concluded and the focus has shifted towards economic recovery and reducing the extent of the Government’s economic intervention.

Low interest rates, and the RBA’s commitment to keep them low until at least 2024, will support the Government in refinancing its debt and locking in lower rates. These moves do carry a risk, in that more Government intervention and support might be required. While we have seen some support for the tourism and entertainment sector this has been more limited and we may also see, given the risk of new outbreaks, a need for further Government support given JobKeeper is no longer in place as a fallback option in the worst-case scenario of prolonged lockdowns.

Inflation

The inflation outlook remains subdued. A strong Australian dollar acts to reduce inflation from imported goods and services, whilst making it harder for our foreign trade partners to purchase Australian goods and services. Meanwhile, the strength in the property market does not translate directly into higher consumer inflation (CPI). While the jobs market is improving there is still substantial scope for improvement without triggering a surge in wage growth. Underemployment is a key issue. This suggests that while there might be some pick up in inflation from the lows that we saw due with the 2020 lockdowns, it is unlikely to be extreme or sustained.

Australian dollar

At present the path of least resistance suggests a higher Australian dollar. Global economic recovery from coronavirus lows suggests strong demand for commodities which boosts our export sector. Our superior handling of the pandemic also supports the relative attractiveness of Australian assets, another support for the Australian dollar.

Economic growth

Households have built up substantial savings over 2020 thanks in part to Government stimulus efforts. Given strong consumer confidence this should see some improvement in private sector spending to drive the economy this year. The removal of inter-state border restrictions allowing domestic tourism and trade to recover is another important tailwind.

Key risks that may emerge include the drag of lower population growth with international borders likely to remain closed in the near-term. Another is the prospect of any further deterioration in our relationship with China. To date China has levied punitive measures including a de facto ban on Australian coal. It has not escalated further into our most important export iron ore and we envisage an uneasy détente to mark the rest of 2021.

Lastly, we expect further Government support will be forthcoming if required by another coronavirus emergency. On balance, 2021 will be a year of further improvement and recovery.

If you have any further questions, please speak to your Financial Adviser.

Source: IOOF Research