Westpac Weekly
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AUSTRALIA & NEW ZEALAND WEEKLY. Week beginning 27 September 2021 Editorial: RBA rate hike in March quarter 2023 still likely but inflation target should be lowered. Australia: Q3 AusChamber–Westpac business survey, retail, housing, private sector credit. NZ: employment indiator, building consents, business and consumer confidence. China: PMIs, current account. Euro Area: unemployment, CPI. US: durable goods orders, home prices, consumer confidence, personal income, spending and prices. Key economic & financial forecasts. INFORMATION CONTAINED IN THIS REPORT CURRENT AS AT 24 SEPTEMBER 2021. WESTPAC INSTITUTIONAL BANK EDITORIAL RBA RATE HIKE IN MARCH QUARTER 2023 STILL LIKELY BUT INFLATION TARGET SHOULD BE LOWERED Last week RBA Governor Lowe gave another brilliant speech on the The contraction in the economy in the September quarter (Westpac Australian economy and the outlook for policy (“Delta, the Economy is forecasting –4%) will certainly widen the output gap near term. and Monetary Policy”, 14 September 2021). But we expect that growth in the economy will be 7.4% in 2022 driven by the reopening of the NSW and Vic state economies, which The single most significant contribution to my understanding of the we expect will be supported by adult vaccine rates nearing 90%. Australian economy over the last 25 years has been the insights in the speeches of Governor Lowe; Deputy Governor Lowe; Assistant Although output levels will return to the path established prior Governor Lowe and Dr Lowe during that period. to Delta, there will be some net loss of output over the period of around 0.75% of GDP – widening the output gap relative to the He is always insightful and often causes the listener to challenge expected path pre–Delta. their thinking about economic issues. But this recovery will be quite different to earlier pre–COVID On June 18 Westpac brought forward its timing for the first RBA recoveries as supply constraints will play a critical role. rate hike to the first quarter of 2023. We expect the cash rate to reach 0.75% by end 2023 and peak at 1.25% by end 2024. Those constraints will be apparent in the labour and goods markets. That historically low peak reflects the vulnerability of Australia’s We expect foreign borders to be closed until mid–year and the household sector due to the expansion of household debt. It has pace of return to be slow. Relative to March 2020 temporary expanded and is expected to continue expanding to the point where visa holder numbers are down across the board by over 250k – a 1.25% cash rate would be consistent with those peak household including students; skilled employment; and working holiday. We debt servicing ratios which have been associated with a slowing in expect population growth of around 0.4% in the first half of 2022 the Australian economy in previous cycles. followed by 0.6% in the second half compared to pre–COVID annual population growth of 1.6%. In his speech Governor Lowe noted: “I find it difficult to understand why rate rises are being priced in next year or early 2023” – referring There will also be some constraints on labour supply due to to market pricing. workplace vaccination mandates and the prospect of around 10% of the adult population remaining unvaccinated. He restated his own view that “Our judgement is that this condition for a lift in the cash rate will not be met before 2024.” The labour market and wages He strengthened the statement by raising the stakes in terms of his Consider the dynamic pre–Delta: between June 2020 and June 2021 inflation guideline: “It won’t be enough for inflation to just sneak across the unemployment rate fell from 7.6% to 4.6% with the economy the 2% line for a quarter or two. We want to see inflation around growing by 9.6%. the middle of the target range and have reasonable confidence that inflation will not fall below the 2–3 per cent band again.” We expect that the unemployment rate will start 2022 at around 5.4%. Strong demand growth, constrained by supply This specific point target is more challenging than the usual policy restrictions, including slow population growth, are likely to see the approach of 2–3% on average over the cycle – he wants to see at unemployment rate fall to 3.8% by year end. least one 2.5% print on underlying inflation. We have not experienced a national unemployment rate below 4% The Governor’s forecasts in the August Statement on Monetary in Australia since the early 1970s. Policy show why he is not hopeful of that objective being achieved any earlier than 2024. These supply factors will impact other countries as well, lifting wages growth and containing some of the usual disinflationary By December 2023 he expects the inflation rate to have reached effects of globalisation on wages. 2¼%; the unemployment rate to have reached 4%; and wages growth 2¾%. The steady trend in his forecasts point to 2.5% being Once the unemployment rate falls below full employment (around reached by mid–2024, implying any policy response is likely to be in 4–4.25%) there is likely to be some acceleration in the upswing the second half of 2024. in wages growth. By the September quarter, 2021, wages growth is expected to be around 2.2%yr – a reasonable starting point for It is therefore with some trepidation that we are sticking with our getting close to 3% by end 2022. forecast that the first rate increase (0.15%) will be delivered in the March quarter 2023. Inflation The Governor would accept that the policy outlook three years into The outlook for inflation has an unusual degree of uncertainty. the future is essentially a forecasting exercise. Goods markets are facing constraints as supply chains have been We expect the conditions necessary to justify that initial rate hike to disrupted. On some measures global container freight costs have be achieved much earlier than indicated in the RBA’s forecasts. increased by a factor of five. Disrupted supply lines are causing difficulties in the face of booming demand with inevitable price We recognise that more than in any other cycle the level of pressures emerging, imported durables including motor vehicles are uncertainty around these forecasts is extreme. experiencing price increases while building materials costs for timber and steel are also being affected. This is not just because of the immense uncertainty around the health situation but also because of the unusual mix of demand Globally, markets and commentators are adjusting to the likelihood and supply forces driving inflation; the labour market and wages. that these factors will persist for much longer into 2022 than previously expected. Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts. Westpac weekly 2 Research from the Dallas Fed points to around 25% of the excess of Is it a good trade–off? headline inflation over underlying feeding back into underlying over the next year in the US – capturing the indirect effects of a sharp This far out and in these uncertain times there is the prospect increase in some components. that we will be wrong with our inflation; unemployment and wage growth forecasts which may fall short of the Governor’s specific Locally, rising housing construction costs have been held down by targets by early 2023. subsidies that have now run off, exposing the CPI to a sharp upward adjustment from that component near term. The question then is the value of the trade–off: a few percentage points on the inflation rate relative to the prospect of significant The expected lift in wages growth will give the key boost to inflation disruption to the Australian economy with a surge in dwelling through 2022. Our point estimate, admittedly surrounded by a wider prices to unsustainable levels and the associated vulnerability of the than normal ring of uncertainty, sees the Governor achieving his economy to the next upswing in rates. 2.5% inflation target in the December quarter 2022. Inflation target needs to be brought into line with other countries Reaching the inflation target earlier than expected should be good news Recently the OECD proposed a review of the RBA, highlighting its failure to achieve its inflation target (annual trimmed mean inflation Readers might sense that our forecasts would be ‘bad news’ for the has not been above 2.5% since mid–2014.) Governor. My view is that the RBA’s inflation target has been too high for too Indeed, quite the opposite. Achieving the inflation and full long. Set at 2–3% over the cycle, it was first referred to in August employment targets much earlier than expected would allow the 1992 when inflation had averaged 6.4% over the previous 7 years; Governor to avoid the dangerous prospect of the impact on asset the 10 year bond rate was around 8.5% and the cash rate was 5.75%. markets of four consecutive years of a 0.1% overnight cash rate. We did not have break–even measures of inflationary expectations Dwelling prices have already lifted by 17.5% over the last year, the in the bond market at the time, but it would be safe to say that strongest annual house price increase since 2002. Affordability expectations were much higher than the 2% we have today.