Wind in the Sails But Storm Clouds Remain

2022 is shaping up to be a bumper year after a tough run for the Australian economy. And while the economy should sail faster in 2022, there is still considerable uncertainty over the outlook.

We are anticipating strong growth in 2022; indeed, we expect economic activity to grow well above its long-run average. A cocktail of factors will put wind in the sails. These factors include low interest rates, a recovering labour market, the massive savings accumulated by households, a strong housing market and generous tax incentives for businesses.

Encouragingly, the Australian economy showed incredible resilience over the past two years. Indeed, the contraction in economic activity during the national lockdown in 2020 and the delta lockdowns in 2021 were nowhere near as deep as feared.

But the impact of the pandemic has been uneven. Conditions have been very tough for some industries such as hospitality, tourism and arts & recreation. Greater labour mobility, the unencumbered reopening of borders, and relatedly an uplift in population growth, are crucial to the recovery of these industries.

In recent weeks, the emergence of a new COVID-19 variant, Omicron, has served as a reminder that we still could face more stormy waters. If Omicron, or other new variants that emerge, lead to poorer health outcomes and force governments to re-introduce prolonged lockdowns, then growth will be clipped.

Inflationary pressures may also prevent clear sailing. Disruptions to supply chains and labour markets from the pandemic have been significant. The relaxation of restrictions around the world will help to ease these pressures. However, it will likely be some time before the substantial supply bottlenecks that have accumulated during the pandemic will be entirely resolved.

These disruptions have led to price rises, especially for raw materials and labour. The Reserve Bank (RBA) suggests that if the supply problems are resolved quickly, then these pressures will be transitory. However, there is a considerable possibility that some of these pressures will persist, given the likelihood that supply disruptions will persist for some time yet.

The economic recovery combined with these inflationary pressures has led markets to price in an RBA cash rate hike in the second half of 2022. We think this is too aggressive and expect the RBA to begin hiking in early 2023, although a move in late 2022 cannot be entirely ruled out.

Financial markets will continue to try to nut out when the RBA is likely to tap on the brakes. This will retain volatility as a feature of investment markets heading into 2022, as will possible developments with Omicron.

Besa Deda, Chief Economist
3 December 2021