A Big Speed Bump
Changing Covid restrictions in Sydney and Melbourne over the past week will hurt Australia’s Q3 GDP growth rate more than we previously forecast. The introduction of a harder lockdown in Sydney over the weekend, including for the first time the construction industry, plus Melbourne’s five-day lockdown announced last week that looks likely to extend will have a big negative impact on economic growth in Q3, even allowing for mitigation from Federal and State government income support programs.
Just one week ago we thought that real GDP would lift 0.5% q-o-q in Q3 on the key assumptions that Sydney’s lockdown would end in early August and containment of small covid outbreaks in Melbourne and Brisbane requiring no lockdowns. Over the past week, stubbornly high community transmission of covid in Sydney plus the much smaller but growing cluster in Melbourne place Sydney in lockdown through to mid-August at least and Melbourne in lockdown into early August. On these new assumptions about lockdowns GDP falls by 2% q-o-q in Q3 on our forecasts.
While developments over the past week have reduced our Q3 GDP forecast, there is of course no impact on our Q2 GDP forecast, which finished at the end of June. While there were brief lockdowns in Perth and Brisbane in Q2 and Sydney’s initially soft lockdown started on 24th June, essentially Q2 was a strong growth quarter. Look no further than the tumbling unemployment rate down from 5.6% in March to a twelve-year low 4.9% in June for evidence.
Q2 GDP will be out in early September and our forecast is that GDP grew 1.2% q-o-q in real terms, far different from the 7.0% q-o-q fall a year earlier in the depths of the Covid recession. The base effect from the –7.0% q-o-q last year means that annual GDP growth will soar in Q2 2021 to 10.0% y-o-y on our forecast from 1.1% y-o-y in Q1.
Annual GDP growth then reduces sharply in Q3 on our latest –2.0% q-o-q forecast to 4.2% y-o-y. Even with a sharp quarterly contraction in GDP in Q3 Australia will register an annual GDP growth rate above long-term average annual growth around 2.8%.
Whether our –2.0% q-o-q Q3 GDP forecast, and annual GDP growth forecast will need to be tweaked lower is dependent almost entirely on how quickly the Sydney and Melbourne Covid outbreaks are contained allowing the easing of restrictions.
At this stage we see September being the first full month of eased restrictions and a month of increasing spending by Sydney and Melbourne businesses and households.
We forecast a much stronger lift in spending in Q4, a quarter bolstered by renewed rundown of savings by a household sector with more reason to be optimistic. An important reason for greater optimism is that the rising vaccination rate through the second half of Q3 means a much-reduced risk of a return to lockdowns on any new outbreaks.
Australia’s full vaccination rate is currently lifting through 13%, a percentage which imminently will rise sharply with greater demand for vaccination caused by fear generated by the Sydney and Melbourne outbreaks, coupled with a greater supply of vaccines, with a million doses of Pfizer a week arriving in Australia and the rapid opening of new vaccination centres.
By early October/Q4 Australians will be starting to look forward with confidence to the freedoms starting to be enjoyed in Europe and the United States. It is reasonable to expect that growth in spending and GDP will rise sharply. We pencil in a 2.0% q-o-q GDP rise in Q4. In terms of annual GDP growth, the base effect comes into play again. Even though 2.0% is a strong quarterly growth rate it will be less than the super-strong 3.2% q-o-q lift reported in Q4 2020 when the economy was experiencing the first six months of huge lift out of the Covid recession.
Because of the base effect our forecast annual GDP growth rate fades to 3.0% y-o-y in Q4 2021. With still quite strong forecast quarterly GDP growth rates of 1.5% q-o-q in Q1 2022 and 1.2% q-o-q in Q2 2022 annual GDP growth bases out at 2.7% y-o-y in both quarters.
Beyond Q2 2022, our –2.0% q-o-q Q3 2021 GDP forecast pushes annual GDP growth sharply higher. At this stage we forecast 1.0% q-o-q GDP growth in Q3 2022 and that lifts forecast annual growth to 5.8% y-o-y.
While the escalation of the crises in Sydney and Melbourne, with the associated tougher and longer lockdowns, have placed a big speed bump in the way of GDP growth in the current quarter extending to slower than previously forecast annual GDP growth through to mid-2022, a period of faster-than-previously forecast annual GDP growth develops in Q3 2022 and beyond.
The faster annual growth phase, starting mid-2022, is dependent on the greater freedom to live with Covid circulating in the community provided by a high vaccination rate achieved in Q4 2021. One potential downside risk is if the effectiveness of vaccination is compromised by new mutations, then periodic lockdowns may still be needed beyond 2021, promoting a much softer economic growth outlook. At present, with fingers and toes crossed, the stronger 2022 growth outlook is our base case.
On the topic of base effects on annual calculations, it is worth noting that the Q2 CPI is due next week. Our forecast is that the CPI rose 0.4% q-o-q in Q2 2022 (in Q2 2020 it fell 1.9% q-o-q). Annual CPI inflation on our forecast lifts to 3.5% y-o-y from 1.1% y-o-y in Q1. The annual inflation rate will fall back towards 2% y-o-y in Q3 and Q4. However, fast accelerating annual GDP growth in 2022 and all that hangs off that growth in terms of employment and wages means that annual CPI inflation will lift off a base of 2.0% y-o-y during 2022, a key reason why we are penciling in a first RBA rate hike from 0.10% to 0.25% in Q4 2022.