Economic forecasting, even with the aid of the best economic models, is a tricky business at the best of times. The assumptions fed into models are a key influence on forecasts and economic forecasting assumptions often prove to be wide of the mark. The risk of feeding in assumptions that later prove to be wrong has proliferated.
The Covid Pandemic and associated restrictions have introduced the need to make more difficult assumptions in the modelling process. Assumptions about the global economic growth outlook and the performance of key international trading partners have become trickier. Feeding in assumptions about key commodity prices important to Australia has also become harder as Australia’s single biggest trading partner, China, pursues major economic policy change and at a time of heightened tension in Australia’s relationship with China.
In short there are more moving parts than usual in all economic forecasts which implies that the economic outlook can shift quickly.
Assumptions about the plans in New South Wales and Victoria to open up and live with the Delta Variant are ever shifting. Currently, both states are looking to adult vaccination rate benchmarks to ease restrictions slowly over the next month. If the vaccination benchmarks are achieved (highly likely at this stage) life for the fully-vaccinated returns to near normal, including some overseas travel, by Christmas.
On these assumptions domestic spending lifts sharply in New South Wales and Victoria in November and December with momentum carrying through Q1 2022.
The problem is that the assumptions may need to change if, for example, hospital intensive care admissions instead of peaking as forecast continue to rise and force a return to restrictions. An even worse case would be if vaccination is less effective or ineffective against a new Covid variant. Alternatively, high vaccination rates may cause Delta variant infections and hospitalisation rates to subside more quickly and completely than expected, an outcome that might generate much stronger growth in 2022.
The Australian economic growth outcomes are widely different depending upon the course of the pandemic. There is a National Plan and State variants for moving out of the pandemic but those plans only stay firm if the pandemic charts the course expected. If the pandemic charts a different course - something it has been adept at so far - the National and State plans will almost certainly change.
Apart from the uncertainties created by the pandemic, Australia’s changing relationship with its single biggest international trading partner, China, is also creating economic forecasting challenges.
China’s high demand for commodities, especially iron ore, has been a factor lifting Australian export commodity prices, boosting our terms of trade (export prices relative to import prices) and our national income. The peak export price benefit occurred in Q2 2021 and accounts for why nominal GDP growth +3.2% q-o-q, +16.4% y-o-y was so much higher than real GDP growth, +0.7% q-o-q, +9.6% y-o-y.
High nominal GDP growth driven by export prices powers resource company profits, government tax revenue and household income via higher dividends. Part of the high export price story relating to iron ore prices has changed.
China is changing its economic focus towards being more egalitarian and more environmentally conscious. The motivations for the changes are not entirely clear but seem part bound up with presenting China in best light internationally at the Beijing Winter Olympics in February and presenting China in a more appealing light to its domestic population for the key Peoples’ Congress Meeting a few months later. What is clear is that China is clamping down on two big commodity using sectors of its economy, property development and steel production.
Since June, the iron price has more than halved from a peak above $US230 a ton to under $US100. Whether the price falls further or rebounds is uncertain. A continuing clamp down on property and steel through to early 2022 could see the iron price halve again. However, the clamp down has placed China’s biggest property developer, Evergrande, in financial difficulty that could set off a domino collapse of Chinese lenders. Chinese policymakers may relax the restrictions on property developers to avoid a banking crisis and bail out. Whatever the policy decisions inside China, another layer of complexity is added by Australia’s increasingly fragile political relationship with China.
The iron ore price assumptions in Australian economic forecasts are critical in nominal income growth and government tax revenue. Whatever price assumption is made is subject to a high degree of uncertainty in the current environment.
Economic growth forecasts are only as good as the accuracy of their underlying assumptions. The underlying assumptions about the pandemic and China are uncertain and imply an uncertain economic growth outlook ranging from a return to recession in 2022 to above long-term trend growth. One certainty is that with so much uncertainty the RBA will remain very slow to consider lifting official interest rates.