A Week Is A Long Time
Last week we viewed the RBA’s growth forecasts as being reasonable and possibly light-on for 2022. We looked at the RBA’s latest economic forecasts and their baseline position - that the current reduction in GDP growth would be brief and followed by sharp recovery starting in Q4 and extending through 2022. Rapidly evolving developments regarding COVID-19 internationally and at home are now causing us to revisit our view, potentially extending the near-term downturn.
In the past week, escalating new cases of the highly infectious Delta variant in countries with high vaccination rates such as Israel, the United Kingdom and the United States, as well as the smaller but stubbornly hard to contain outbreaks in New South Wales and Melbourne, are raising questions about what level of restrictions may need to persist longer term even when vaccination rates are high.
In Australia, the news on the COVID front has been a mix of good and bad over the past week. Daily new cases pushing above 400 into the eighth week of Sydney’s lockdown has forced an extension and tightening of lockdown throughout New South Wales. The difficult to control outbreak has also made it impossible to ease restrictions for the next month at least.
Melbourne’s daily case numbers, although much smaller than in Sydney, are refusing to batten down, threatening an extended period of lockdown.
The great hope is that once the fully vaccinated proportion of the adult population reaches 70% (currently 25% although rising rapidly) the need for lockdowns will be reduced. While the Commonwealth Government, States and Territories agreed a fortnight ago to this target as the first stage in moving away from harsh restrictions to contain outbreaks, the frightening recent spread of COVID in New South Wales, coupled with less than promising news from countries with high vaccination rates is reducing the likelihood of Australian states moving away from suppression policies even at high levels of vaccination.
The good news over the past week is the immediate delivery of another one million Pfizer doses on top of a delivery schedule already accelerating. Australia is back on track to fully inoculate 70% of the adult population by the end of October. The bad news is that the goal posts for greater freedom are wobbling and restrictions may remain for longer and even when eased eventually may be reimposed quickly on any new waves of infection.
The COVID developments over the past week highlight how difficult it is to forecast with confidence. In just one week our forecast of 2.0% q-o-q reduction in Q3 GDP is not looking low enough. Our view that GDP will rebound in Q4 is at risk. A second consecutive quarter of negative GDP growth is a real prospect if shutdowns in New South Wales and Victoria extend into October.
We still expect a burst of strong growth once current restrictions ease, but we are less convinced than we were that tough restrictions will not be used again if another wave of cases occurs next year. Previously we were looking towards a substantially vaccinated Australia being different. We would live with COVID in much the same way as we live with seasonal flu without lockdowns and with open borders. We are less convinced that a high vaccination rate will generate such a big change and that changes the economic outlook.
Apart from a lower forecast economic growth trajectory, living with restrictions for longer, has implications for wage growth and inflation too. Longer closure of Australia’s international borders is preventing resumption of large-scale immigration. There is also some evidence that Australia’s change towards a country of greatest restriction fighting COVID is encouraging small-scale emigration of people fleeing Australia for greater freedom overseas. The supply of Australian labour is tightening and any increased demand is starting to exert upward pressure on wages.
The Q2 2020 wage price index due this week is expected to show that annual wage growth rose to around 1.8% y-o-y from 1.5% in Q1. By the end of 2020 annual wage growth is likely to push up to 2.5% y-o-y and with the boost to spending and demand in the economy once current lockdowns in New South Wales and Victoria end, will push up through 3% y-o-y in the first half of 2022. Even with a less robust economic growth outlook the RBA will be facing evidence of persistently higher inflation by the second half of 2022.
The injection of greater downside risk into near-term growth prospects helps to keep interest rates low over the next few months but the same factor (the difficulty containing COVID) cruelling near-term growth prospects is also fostering labour scarcity generating higher wages, inflation and interest rates over the longer term.
Lower and less certain growth prospects could march hand-in-hand with higher inflation through 2022 leaving the RBA with the difficult choice of needing to hike the cash rate in 2023.