18 January 2020: We assume that:
(1) Australia succeeds in keeping virus numbers mostly suppressed, state borders remain mostly open, and that domestic restrictions gradually ease as vaccines roll out
(2) Vaccines begin to be available from February, and achieve the equivalent of herd immunity by late 2021
(3) International borders re-open gradually, starting with New Zealand in coming months, broadening to cover much of the world by end-2021 (though it may not be until 2024 that global and Australian people movements are fully back at 2019 levels).
Much of the world has fumbled its virus response, but early and effective vaccines are a gamechanger. That still leaves tough months ahead in Europe and the US as rampant cases drive consumer and business caution, but the big picture is one of strengthening global recovery, with the Asia Pacific leading the way.
Yet the scars from this pandemic will linger, with unemployment set to stay high for some time in most of the globe. Not surprisingly, the world’s politicians are therefore keen to turn attention towards “foreigners” and away from their domestic challenges. The resultant populism – and downright bullying – is unlikely to derail global recovery, but tricky vaccine rollout logistics and fraught geopolitics will both keep the outlook a volatile one.
Australia is one of just five nations – Taiwan, China, Vietnam, New Zealand and ourselves – who enter 2021 very well-placed. COVID numbers are very low, the vaccine news is excellent, confidence is rebounding, Victoria is catching up to the recovery already underway elsewhere, there are heartening developments in job markets, and China’s trade war with Australia has – so far at least – actually added to national income rather than hurt it.
To be clear, although the damage of 2020 is winding back fast, it definitely hasn’t disappeared, and it will linger: the enormous protection provided by the federal government is being dismantled rapidly, the world economy is a mess, and the geopolitical backdrop for Australia looks more troubled than it has been for many years. Then again, a bit of perspective is handy. Australia has made many mistakes in juggling COVID, but so far, we’ve made fewer mistakes than most of the globe. You’d rather be here than almost anywhere else.
Wage and price gains have been on a downtrend for decades, both locally and globally, and the COVID crisis will keep both bumping along the bottom for some time. Inflation may not hit rock bottom until mid-2022, and may not start to climb much until unemployment drops well under 6% – which we don’t see happening until 2023. And, even allowing for the improved recovery prospects accompanying the good news on vaccines, underlying inflation may not get back into the RBA’s comfort zone (of between 2 and 3%) until late 2023 or early 2024.
COVID has crushed interest rates, and even though vaccines mean global recovery looks more assured, elevated unemployment will keep inflation and interest rates on a tight leash, as will central bank caution and the increased power of interest rates in a heavily indebted world. Meantime Australia’s relative outperformance on COVID and the high flying iron ore price have the $A celebrating. But both those factors are temporary, and we see US stimulus as more likely to send the US dollar up than it is to boost the Australian dollar.
Today’s job recovery isn’t one your parents would recognise. Past recessions left lengthy hangovers. Yet although unemployment and underemployment will be much higher than they were pre-COVID, they’re also falling much faster than feared. That’s great. And don’t forget the long term benefits: you can see the impact of recessions for decades afterwards in the income and unemployment experiences of those who were young adults when the storm first hit. So the smaller the upfront pain, the less is the longer term scarring. (Well done Australia!).
In the meantime the excellent news on vaccines will probably limit the longer term damage to Australia’s population growth: migrants look likely to be back in reasonable numbers by mid-2022. To be clear, that doesn’t say everything’s great. But it does say it’s looking much better than it could have, and Deloitte Access Economics forecasts the unemployment rate to be back down to 5½% by mid-2023.
The jump underway in public sector debt isn’t mostly due to COVID-fighting stimulus – it’s because economic weakness is eating into the tax take. That’s why improving economic forecasts are also generating improving forecasts for debts and deficits. And it’s why it’s good policy to fix the economy first and deal with the deficit later: the best medicine for a wounded budget is a healthier economy. In the meantime those debts and deficits have done their job beautifully, saving jobs and protecting incomes through the worst of the crisis.
Even better, by standard corporate measures – net interest cover and gearing ratios – federal and state budgets have taken much less damage than people think. Interest costs continue to drift down as a share of national income, with the impact of higher debt more than matched by savings from the fall in interest rates. (Yes, that’s the right measure to look at – not debt to GDP ratios, as that apples-with-oranges measure mixes up stocks and flows.)
Industries – what next?
2020 negatives were dominated by lockdowns and border closures. That hit airlines, airports, tourism, foreign students, cafes and restaurants, pubs / clubs, hotels and motels, retail, cinemas and entertainment.
Opening back up creates a big bounce. 2021 looks set to continue the recovery in sectors smashed by the lockdowns and border closures of 2020, allowing the likes of accommodation, food, entertainment and airlines to continue to climb back from the abyss. And by 2022 tourists and foreign students will be here in greater numbers. Business conditions AV (after vaccines) will look very different to those BV (before vaccines).
2021 negatives will increasingly look more like those of a typical recession, with sectoral damage centralising in manufacturing, housing and commercial construction, plus in sectors reliant on discretionary spending (including retail and entertainment).
In 2022 and beyond sectoral pain will be dominated by the lower-than-expected population. That’s most challenging for industries whose market size is determined by the increase in population.
Several themes underlie forecasts over the five years to 2024-25. One is structural strengths and weaknesses: the health and information services sectors will grow fast because they have excellent underlying fundamentals (demographics and technology for health, technology for information services). But manufacturing and the utilities will grow slowly given a lack of international competitiveness for manufacturing, and weak population and manufacturing growth for the utilities (other than electric vehicles, tech trends tend to work against the utilities).
Similarly, the return to ‘normality’ will see the public sector’s growth spurt of the moment fade once more, while the shift to very low interest rates for an extended period will help credit growth – and hence help the banks – while it will also generate some momentum for property services.
Finally, the strength of their current rebounds also improves average growth rankings over the next five years in both accommodation and food services (as it rebounds from lockdowns and border closures) and in the farm sector (as it rebounds from drought and as it eventually shrugs off the impact of Chinese bans).
The only thing I disagree with there is the forecast for a turn upwards in the US dollar. That remains more likely a 2022 story as China and Europe slow as the US powers up. Obviously, that would weigh even more on Australian inflation and wages.