If we are in a Goldilocks phase in Australia, which we probably currently are, the more meaningful question is whether this can be sustained and what should we be mindful of in terms of the material risks to this positive phase?
The first key point is that Australia has exited a recession in a unique (rude) state of health. This is underpinned by one factor, fiscal stimulus. Naturally, this combines with accommodative monetary policy, but our study of recessions over the last 100 years pinpoints the early withdrawal or absence of fiscal policy as being the single largest factor in economies not being able to return to their pre-recession economic output and growth rates (Britain 1920’s and Europe post-GFC are examples).
In Australia, the combination of ongoing fiscal stimulus through program expenditure and transfer payments has meant that overall business conditions are more than satisfactory (other than of course the hollowed-out COVID-impacted sectors). Importantly though, households have exited a recession with a vast pool of excess savings. The other key differential for Australia is our closed international border, which has seen spent stimulus committed to domestic demand.
For this discussion, Cameron Harrison confines the outlook period for Australia to the end of 2022. Overall, we remain positive through this outlook with some reservations depending on our closed border status through 2022.
We expect growth for 2021 and 2022 to be robust, with potential downside risk if excess household savings continue not to be deployed through consumption, and iron ore prices are more adversely impacted by Brazil supply normalisation and Chinese demand re-routing. That said, growth in the low to mid 3%’s in 2022 would be highly credible.
Also supportive is private demand led by burgeoning housing starts and which in turn sees housing contribution to GDP exceeding 1% of GDP. A yet to materialise growth component is business investment, which has been at multi-decade lows. With ABS (Australian Bureau of Statistics) business investment intentions at a decade high, we can expect this to make a solid contribution over the outlook period. In this regard, the first leg of the Goldilocks quinella is in place.
The second leg of the Goldilocks quinella is moderate inflationary expectations, which in turn helps to underpin supportive monetary policy. Inflation and inflationary expectations continue to be a significant talking point for markets. The producer price level is certainly showing ‘frothiness’, as are certain COVID-impacted and re-opening sectors at the consumer level.
In both the pre-COVID and post-COVID environment, we remain focused on the wages level. In Australia over the last decade, our working-age population has been growing on average by 1.8% p.a largely through immigration and now, is near-zero growth. Closed borders and the mere trickle of population growth has seen solid absorption of labour capacity through employment growth and therefore, improvement in underemployment following COVID.
The ABS statistics in the chart below show the relationship between the level of underemployment and wage growth. If we accept 8% underemployment, then based on prior observations, wages growth of 2.5% p.a. could be expected rather than the current 1.5% p.a. Additionally, we also follow the Roy Morgan Survey, which shows underemployment at somewhat higher levels than the ABS, at 19% — this suggests there is further labour capacity. Regardless, no one can deny that labour capacity is being absorbed and that this will continue. More particularly, certain skilled labour and business shoring up of labour resources, is likely to see pockets, if not wider economy bidding up of wages. Does this produce wages growth of 3.5% pa targeted by the RBA? We contend that the risk is increasing, but is still some way off. A key factor though, is that if borders remain closed until mid-2022 or beyond, then skill shortages and wages growth may become hugely problematic in Australia and particularly for policy makers, namely the RBA.
Management of inflationary expectations will place the RBA into a difficult corner to raise interest rates before 2024 and potentially see the Australian dollar pressured to rise well over USD $0.80.
For Australia, we think our Goldilocks outlook may potentially start to deviate significantly from other Western economies through 2022, with much hinging on wages growth and the reopening of international borders to (vaccinated) students, travellers, skilled and seasonal workers.
Time will tell, but ultimately, we think that the States and Commonwealth are equally motivated to at least see borders open for this inbound cohort to ease labour market pressures, re-establish education export earnings and ensure that wages growth is steady and not interest rate inflammatory (which would negate housing affordability occasioned by low interest rates).
It’s probably fair for Goldilocks to have some apprehension going into 2022, especially with much riding on the political judgement to at least partially open up the inbound international border and ensure the porridge doesn’t get too hot!
Cameron Harrison have been advising business owners and their families on asset allocation and intergenerational wealth management for over 50 years. We have demonstrated over a long period our ability to manage investments through both the good times and bad by keeping the client at the centre of our business.
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