Stuart's Breakfast Orange; The “Lucky” Country in “Lucky” 2021 – A Pontoon Bridge to Normality

Now that specific certification is no longer necessary, we all want to be Australian, at least for 2021 and maybe 2022. Australia, and its better rugby playing neighbour New Zealand, have become models for this pandemic. Suppress the virus domestically, but prevent importation of new infections and more virulent strains by closing down borders;  domestic services can then thrive, and more importantly, life can return to "normal" without the disabling "mortality" fear.

Foreign travel, tourism and education services remain depressed, but with plentiful liquidity from the Reserve Bank of Australia and RBNZ, and record expansion of fiscal policy, consumers have had the means to increase spending on other sectors.  

The success of Australia's pandemic strategy has resulted in a smaller than expected decline in GDP during 2020, and the Reserve Bank of Australia expect that real activity will return to its end-2019 level by the middle of the year, 6-12 months earlier than previously thought. The Real GDP decline of 2% in 2020 was, excluding China, the best performance of any major economy. Last August, the RBA forecast that the unemployment rate could rise as high as 10%, but the rate peaked at 7.5% and by December has now dropped to 6.6%. The RBA expect above-trend growth over the next couple of years, with real GDP expanding by 3.5% in 2021 and 2022.  However, the sharp slowdown in immigration has caused their estimate of population growth to be revised from 1.6% to just 0.2%, which has lowered their long term trend forecast. It is a reminder of how dependent Australia has been on immigration growth and along with unbalanced Chinese demand for commodities, cannot be relied upon in the future. Additionally, the drawbridge to foreign travel is likely to remain raised until the autumn and only then will it be lowered to selected countries. The recent suspension of the travel corridor from New Zealand to Australia, following the identification of just one infection, suggests minimal tolerance. The world is not expected to be fully vaccinated until the end of 2023, but covid is expected to continue to evolve and mutate, the mutations are not a rapid as traditional flu, but experts suggest that we will require booster shots and travel restrictions from some countries are likely to continue over the next few years.

Nevertheless, like the vast majority of private-sector economists, I believe that the official economic forecasts are underestimated. The strength of Australian consumer confidence and global commodity prices suggests that growth will easily exceed the RBA's estimate, and there is room for this momentum to carry over into 2022. I believe the unemployment rate will fall faster and further than the central bank's expectation of 6% by the end of the year. However, last year's best performers are unlikely to be top of the league this year because they have less to recover. My "fizz then fizzle" outlook for the global economy suggests that while fleeting attainment of the prior trend cannot be ruled out, return to the pre-Covid trend rate on a sustained basis is pushing the lucky tag too far. 

Faster growth will be accompanied by higher inflation. The RBA expects headline inflation to peak at 3% in June before dropping down to 2% by the end of the year. According to the RBA, the temporary acceleration reflects frictional inflation generated the swings in the price of child care and other administered prices that were lowered in the pandemic. The central bank believes that underlying inflation will remain well below the midpoint of its 2-3% target range, indeed the central forecast for 1.25% and 1.50% respectively for 2021 and 2022 with the presumption that the policy rate will remain at current levels until 2024. 

The RBA justified QE's extension by a further A$100bn, at the same pace of A$5bn per week, based on these low inflation expectations. Wage inflation is at decade lows, but the central bank is equally concerned about the impact of the end of the Job Keeper allowance in March and the Term Funding Facility in June. The latter will allow banks to maintain low-cost funding out until the middle of 2024, which reinforces the presumption that rates will be on hold until 2024. The central bank is determined to limit currency appreciation, but Australia is a price-taker of global rates, its ability to contain the resurgent Australian Dollar depends on whether Fed policy stabilises the US Dollar. Price taking central banks have to maintain ultra-accommodative monetary policy to limit currency appreciation. Governor Philip Lane repeated his opposition to negative rates but maintained the cognitive dissonance that the central bank can simultaneously control both the price and the quantity of its government bond purchases. 

Australia is a role model for the normalisation of the domestic economy. Its better performance during the pandemic means that it will return to pre-pandemic GDP level sooner than other major industrialised democracies, but its determination to maintain ultra-loose monetary policy means that it will also face earlier accusations of diverging growth from policy. These accusations will pressure the central bank to become less accommodative as growth and inflation exceed official expectations, and risk markets continue to outperform. 

I believe that central banks should resist this pressure because the history of pandemics is that after a meaningful period of revenge spending, consumers and corporates increase their savings, creating the paradox of thrift. But the best-laid plans of mice and men aft gang agley as our [currently very happy] Scottish rugby supporting poet once said.

Stuart Thomson is an independent economist and strategist. His writings reflect his personal views and are intended for the reader's entertainment and to elicit debate. They are not intended to constitute investment advice.