Markets turmoil and interest rate rises: the economic challenges facing Australia after the election
At the end of last year, many signs pointed to Australia’s economy reaching a post-Covid sweet spot right about now, in the middle of the election campaign. Even Reserve Bank governor Philip Lowe was confident 2022 would be rate-rise free.
But that was before most central banks – including Australia’s – underestimated the strength of demand coming out of the pandemic and resulting plunge in joblessness, Russia’s February invasion of Ukraine and energy and food prices soaring.
So what will be the leading economic challenges facing a new or returned government after 21 May? And could financial markets turmoil add a last-minute campaign twist?
Can GDP growth be maintained?
“A strong expansion in the Australian economy is under way and inflation will increase further,” was how the RBA summarised part of the outlook section in its quarterly statement on monetary policy last Friday.
The economy grew 4.2% in 2021 and the central bank is expecting a similar pace – 4.5% averaged over the year – for 2022.
Looks pretty steady, right? Well, getting there won’t be a given.
“Compared to even just a few months ago, the headwinds are definitely much stronger than they have been,” Cherelle Murphy, EY’s chief Oceania economist, says.
“And much of that has been because of international factors, which we know well, like the war in Ukraine, and the China [Covid] lockdowns as well, which are obviously a concern to us, given our reliance on that economy as our biggest trading partner.”
More costly fuel and price increases for newly built dwellings – linked to the war and China supply issues, respectively – accounted for almost half the March quarter’s headline consumer price inflation spurt to 5.1%. Cue last week’s RBA rate rise.
Both RBA and treasury predict GDP growth to slow back to the 2% range by 2023.
RBA on the move
The 1.1 million or so Australian property owners who had taken out mortgages since November 2010 when the RBA last raised its cash rate wouldn’t have welcomed the increase. However, the novelty came after 18 consecutive cuts to a record low 0.1%, so some rise was inevitable.
That didn’t make it any easier for the Morrison government to explain the extra costs about to be loaded on to borrowers. The next treasurer, though, better block out some time on the first Tuesday of most months to come if investors are any guide.
Economists aren’t so bullish but most pick at least four more hikes in 2022 alone. The RBA, for its part, is predicting the cash rate to peak at 2.5% by the December quarter of 2023.
Independent economist Saul Eslake says the central bank has some reason to be confident that it can contain the inflation spike that will prompt those rate hikes.
Each rate rise sucks some of demand out of the economy, easing on the margin part of the inflationary pressure. And – short of some other unexpected supply shock – some of the major sources of inflationary pressures “are actually receding”, Eslake said.
“The spike in global inflation we’re seeing at the moment, that began around this time last year in the US with big increases in the price of consumer durable goods,” he said. The imbalance in supply and demand, as shown by falling prices for many products such as semiconductors or sinking costs of shipping, appears to be easing.
“If the impact of a conflict in Ukraine on energy prices has passed by, say, September or October, then probably inflation will be clearly on the decline,” Eslake says.
The next treasurer will have to decide whether to extend the halving of the fuel excise beyond September when the $3bn, six-month measure is due to end. The 22.5 cent per litre saving for motorists also trimmed headline inflation by a quarter of a percentage point in the June quarter alone, the federal budget estimated.
But it’s not just liquid fuels increasing in price and feeding higher costs more generally. Wholesale power prices rose two-thirds in the March quarter to $87 per megawatt hour, the Australian Energy Market Operator (Aemo) reported last month.
Accounting for roughly one-third of retail bills, the jump in generation costs is already showing up in utility charges with some New South Wales consumers hit with 30% tariff increases.
Big electricity users in NSW and Queensland can expect 20% increases or more, says Bruce Mountain, head of the Victoria Energy Policy Centre. Critical will be how the federal government works on supporting states in their decarbonisation efforts.
“The states have the bit between the teeth, and the commonwealth has rejected the most effective intervention it could have presented – pricing emissions,” Mountain says. With a carbon market ruled out, one supporting storage may be the next best thing.
“[The] focus should be squarely on storage policy and ensuring the growth of the industry, in a similar way that its renewable electricity policy has been effective in growing the renewable generation sector,” he said.
As the CPI heads towards 6%, calls from unions and others are mounting about the need for higher wages – a challenge for the next treasurer and all of the state ones.
NSW, for instance, has a public sector wage cap of 2.5% a year that next month’s state budget will likely increase. The Fair Work Commission, too, will have to rule on how much to lift the minimum wage.
Last year’s 2.5% increase to $20.33 must be lifted by 5.5%, the Australian Council of Trade Unions argued this week as it upped its earlier claim for a 5% gain after the 5.1% March CPI spike.
The ACTU secretary, Sally McManus, said workers on average lost $800 in 2021 alone in real terms as salary increases failed to keep pace with inflation. The retreat in the first half of 2022 alone would be a further $2,000.
“Working people are facing a cost-of-living crisis driven by nearly a decade of low wage growth capped by real wage cuts under this government,” she said. “These are the cleaners, aged care staff and millions of other frontline workers who carried us through the pandemic.”
Business groups, such as the Australian Chamber of Commerce and Industry, are arguing for a 3% increase in the minimum wage, saying that lifting wages without productivity gains will only stoke inflation and result in RBA rate hikes.
“The Reserve Bank is still targeting an inflation rate of between 2-3%,” ACCI chairman’s Andrew McKellar says. “So we’ve got to get inflation back to a level that’s sustainable.”
Other measures that boost productivity, such as cheaper childcare and more vocational training, should be a high priority for the next government. “At the moment, we’re still seeing pretty weak signs in terms of what’s happening on productivity,” he said.
Market turmoil too?
Could Australia’s election campaign overlap with the start of a financial meltdown, adding to the task list of the new or re-elected government.
Fears of a combination of slowing growth, even recession, and rising inflation – or stagflation – have lately riled investors, sending the price of many assets tumbling.
The board S&P 500 of major US shares are now posting their second-worst start to any year, with about US$9tn (AU$13tn) of stock value erased, Bloomberg says. On Wednesday, US time, the index closed at its lowest since March 2o21.
Past treasurers have had to cope with volatile markets but usually had time to get their feet under the desk first.
The 1987 stock market crash in October 1987, for instance, landed about three months after the Hawke government’s re-election, Peter Costello had a couple of years to hone his tools before the Asian financial crisis in 1998, while Wayne Swan was a couple of months into the treasurer’s job before the global financial crisis.
Eslake – who counts his advice as an ANZ economist that the 1987 crash would have little economic impact as among his career’s best assessments – says Australia’s economy has momentum that should enable it to ride over a few more road bumps yet.
Households, for instance, have some $275bn in bank deposits garnered since Covid began to assist with rising costs of living and higher debt repayments.
“Both the Reserve Bank and the Treasury are forecasting that real consumer spending will rise by more than 5% this year,” he says. “That’s the highest since 1984.”
The Australian dollar’s drop below 70 US cents to the lowest in almost two years won’t cause too much grief to a new treasurer or to the RBA “provided it doesn’t fall too fast”. Australian exports will benefit including hard-hit tourism and student sectors.
“If the [US Federal Reserve] eventually raises rates to levels that cause recessions in the US or perhaps more likely in other parts of the world, or currency crises in other parts of the world, that’s probably more likely the avenue [of hurting Australia’s economy] than something happening in the stock market,” Eslake said.