Economic Updates

There have been twists and turns aplenty in the outlook for the global and Australian economies so far this year. Stronger for longer with central banks behind the curve tackling inflation, gave ground to central banks fighting to catch up with aggressive rate hikes prompting recession and now inflation is beaten so central banks can be less aggressive on the monetary brakes and the recession risk is fading.

Has the RBA braked hard enough to deliver slow enough growth to deliver annual inflation back inside 2-3% target band over the next 2-3 years? The question comes with a couple of tweaks – braked hard enough with the addition of one or two more rate hikes and slow enough growth without tipping the economy in to recession. It will be a very hard monetary policy delivery act to get just right.

Financial markets rallied strongly in July with the notable exception of the Chinese markets. The bond, share and credit buying spree drew on perception that peaking inflation may give central banks cause to reduce the size and pace of future rate hikes, even though big rate hikes were delivered by several central banks in July. Most commodity prices weakened in July on softening global demand increasing the likelihood that annual consumer price inflation will moderate in coming months. Annual inflation in 2023, however, still looks set to base above central banks’ targets implying to us that any pause or moderation in rate hikes over the next few months will be temporary.

Shortages of labour are a major problem facing most private and public sector employers in Australia. The extent of the problem is illustrated in the June labour force report issued last week and showing the unemployment rate down at a 48-year low 3.5%. Over the last 12 months the unemployment rate has fallen from 4.9% or by 188,500 people and now stands at 494,000 matching almost one-for-one reported job vacancies, 480,000 in May. Before the pandemic there were more than three unemployed people for every job vacancy. Australia has entered over-full-employment which tends to drive faster wage growth adding to the range of factors pushing up inflation at present.

When economic data are released, they relate to periods weeks or months earlier. Later this week the June labour force report will be released reflecting a survey conducted in the first two weeks of June. Beyond the six-week reporting lag in the June labour force report, it was decisions made in May and earlier by employers that generated the June data.

Financial markets traded weaker in June with the notable exception of the Chinese markets. The growing risk of recession down the track loomed large in June as high inflation prompted several big central bank rate hikes with the prospect of more to come and quickly to temper demand and cap inflation.

High inflation and central banks starting to front-load monetary policy in response brought the prospect of recession into sharper focus in June even though current data readings still show firm economic growth. Inflation is proving slow to peak challenging central banks and making it more difficult to dial a soft economic landing, even in countries where economic growth is firmly underpinned such as the US and Australia. Previously pumped-up demand to deal with the growth crunch from the pandemic in 2020 and 2021 continues to run well ahead of limited supply. Disruption to supply chains has worsened with the Ukraine War and China’s shutdowns dealing with Omicron. Central banks in May and June have started to admit that they are now actively working to contain demand growth to match limited growth in supply of goods and services.

Inflation running much higher than central banks expected previously is causing them to rethink the appropriate monetary policy response to tame inflation. Most, including the RBA, are admitting that demand growth is running faster than growth in supply of goods and services and with little chance of materially lifting supply near-term because of continuing supply chain problems made worse by the Ukraine War and China’s Omicron lockdowns, slowing growth in demand towards growth in supply is the only way to cap inflation and bring it back down close to inflation targets. Using blunt-edged monetary policy to batten down demand growth is high risk and could easily go too far. Recession risk is rising.

Financial markets remained volatile in May torn between evidence of strong economic activity and concern that central bank interest rate hikes will dampen future activity and possibly lead to recession. Inflation and its many underpinnings are driving the likely course of central bank rate hikes. Views about central bank rate hikes are varied, adding to market volatility.

Global economic growth is losing pace weighed by lessening monetary and government budgetary policy support as well as rising cost of living pressures. Downside risks to economic growth abound from rising interest rates, disruption to food and energy supplies as the war in Ukraine continues and China’s reliance on lockdowns to contain Covid outbreaks. Yet the underpinnings for economic growth remain firm from low unemployment rates in many major economies as well as the past build-up of household savings. If global recession lies ahead, it is not on the cards for another year at least.