Goodbye (and good riddance) to 2020

Chief Economist's View

Download the PDF version including our economic update by region here: Goodbye (and good riddance) to 2020

1. How quickly will the Australian economy recover from COVID?

We will continue to see steady, if not spectacular, above trend growth rates over each quarter of 2021 and even into the first half of 2022 as long as we can keep COVID at bay. We are forecasting GDP growth of 3.3% in 2021 and 3.6% in 2022, following a drop in GDP of 2.8% over this year. We should get back to the pre-COVID level of GDP by the September quarter of next year, though the recent strength in the labour market recovery means that reaching this level by the June quarter next year is now a possibility.

2. Will deteriorating trade relations with China undermine the Australian recovery?

Resource exports to China account for about 6% of our annual GDP, of which iron ore exports for about 4%. Exports of non-resource goods and services to China account for around 2% of GDP. Although a minnow in trade terms, Australia is not without clout of its own, being the largest producer of iron ore in the world, controlling over 60% of world seaborne supplies, and it is likely that China will continue to rely on Australian iron ore exports for many years to come.

Also, our flexible exchange rate provides a potent shock absorber in the event that China curtails its demand for our non-resource exports. In an extreme case that leads to a permanent loss of Australian non-resource exports to China, we estimate that Australian GDP would fall by 1.2%, less than the 2%-of-GDP loss of China exports as a 5% devaluation of the AUD cushions the impact.

3. Will the RBA continue with QE?

With governments having borrowed heavily to support the economy, further QE will help keep interest costs sustainable, while also lowering rates for businesses who must eventually takeover from the government and the household in driving jobs growth. QE has also helped in limiting the rise in the $A, which has become increasingly important given other central banks’ monetary policies and the iron-ore led surge in our terms of trade.

There is little downside to extending the QE program beyond May of 2021: inflation remains stubbornly low, reinforced by record low wage growth, and the $A continues to rise. An extension of the QE program will still have a positive impact on the Australian economy as long as RBA’s bond purchases lower interest rates without inverting the yield curve. With yields on Commonwealth government three-year bonds fixed at 0.1% and 10-year yields currently trading at around 1%, the RBA can extend QE to flatten the yield curve and ease pressure on the currency.

4. Are current housing market conditions sustainable into 2021?

A housing bubble is a real risk, given where interest rates are and likely to be over the coming two-to-three years. In addition, households have built large pools of savings and the economic backdrop is improving, providing further encouragement to the demand for housing.

But the RBA won’t let a house price bubble form as the risk to the economy of an eventual burst is too great as long as the economy is still dependent on continued household spending. If house prices take off, the RBA will work with APRA to reintroduce regulations that will limit bank loans for the purpose of investing in housing and will also tighten bank lending standards; measures that were so effective at squashing house prices back in 2018.

5. Will the deficit be as large as the government is expecting and should it end the JobKeeper program in March?

The government’s 2020/21 deficit revision to $197.7 billion looks reasonable, but Treasury’s iron ore price and labour market forecasts through 2021/22 are overly pessimistic. Stronger iron ore prices and a lower unemployment rate will see the 2021/22 deficit dip below $100 billion, compared with the MYEFO forecast of $108.5 billion. The recent dramatic decline in the number of JobKeeper recipients suggests that the JobKeeper program will be a victim of its own success. The sharp fall in the number employees working zero hours shows that many workers have successfully transitioned back from being ‘stood down’ to genuinely working again.

Combined with the strength in employment, which is now just 1.1% below its pre-COVID level, we see little justification for further extensions of the JobKeeper program, provided Australia can remain free of any additional severe lockdowns. If the Australian economy can continue its recovery, the government should target external facing industries, such as tourism, for support measures as well as a further extension (or permanent entrenchment) of higher unemployment benefit payments.

Table 1: Financial market movements: 10 - 17 December 2020

Source: Bloomberg