Economic outlook – October 2022

by | Oct 28, 2022 | Uncategorized | 0 comments

Earlier this week we tuned in to Bill Evans outlook for the economy post Jim Chalmers first budget on Tuesday. I have highlighted some key points and made some of our own comments below.

  1. Westpac under shot the cash rate forecasts significantly between March 2022 and October 2022 ( forecast was for 1% cash rate in October and it is now 2.6%). That said, the forecast cash rate peak is mid 2023 at 3.8%. Bill’s response was that the steepness of the rate rises was not anticipated but the long term outlook is similar.
  2. Westpac’s October 2022 forecast for the AUD dramatically was wrong. It is currently at $0.64 to the US dollar; in the forecast it was $0.75. The main driver for this is the rate at which the U.S. Treasury has been raising rates and a subdued demand for Australian coal and gas.
  3. The budget is incredibly modest from a spending perspective. We have not seen a spending budget of this little for many years and it lines up with the Reserve Bank strategy of suppressing economic and consumer demand. Bill referred to the bond market vigilantes who are well and truly driving interest rate policy at the moment (just take a look at what happened to Liz Truss in Britain). Australia has not entered the territory of Britain but our government is certainly falling in line to the tune of the Reserve Bank. We think this is good thing for the long term outlook.
  4. The deficit is forecast to be $43 billion lower than in March but the major concern is that it will peak over the long term at 47% of GDP whereas pre COVID it was less than 30% of GDP. Westpac thinks this a disturbing deterioration in the fiscal outlook.
  5. There has been a big reassessment of infrastructure spending reducing by 6 billion with a significant impact in the regional centres suffering cutbacks.
  6. There is nothing in the budget for small business and there is a resounding silence on potential industrial relations changes that will see industrywide wage bargaining and potential strike activity. This is a major concern for SME’s.
  7. CPI is forecast by the government to peak at 5.75% (Westpac consider it to be 5.5% ) and falling back to 3.5% by mid 2024.
  8. Wages growth is anticipated to peak at 3.75% over the next 24 months. Westpac considered it will peak at a higher rate of 4.5%.
  9. The economy should prepare for a slow down in consumer spending in 2023. The main drivers of inflation which are supply chain shocks, energy prices and food prices are all easing.
  10.  Continued price rises are now occurring because the world population has shifted to price rise expectations. (Bill calls it the psychology of inflation)
  11. Labour shortages is seen as the biggest limiting factor for business. This is the first time that labour has been the primary factor since the 1970s. This has been fuelled by the closure of borders where there is approximately a 600,000 gap in migration that at current levels will not be filled.
  12. Lending to businesses in SME land has contracted. This aligns with our experience with our existing clients and is clearly a big concern. Be very wary of the non banks charging you deceptively high interest rates under the misapprehension that they are saving your business.
  13. Pressure on the cost of building is easing across all sector’s covering labour materials and developer margins.
  14. The big question is when will rates stop rising. According to Westpac this will be driven mostly by The US Federal Reserve and when it will stop raising rates. Westpac consider this will be the first quarter of 2023 which will then see long term rates in Australia start to ease with the 10 year bond rate peaking at 4%.

Conclusion

The RBA’s cash rate will rise quickly peaking at 3.1% by December and rising further to 3.6% by March 2023. High household debt will limit rate increases as debt servicing ratios decline and place pressure on consumer demand. The risk in the economy is a wage/price spiral which will potentially break the forecast upper limit for inflation.

Expect house price reductions of up to 20% in Sydney and Melbourne (nationally 16%). With the borders reopening we are unlikely to see replacement of COVID losses in the workforce which will keep upward pressure on wages. The low point in the economy is considered to be the second-half of 2023. We will continue to monitor the Westpac outlook (which is as good as any) and keep you abreast of any changes. Of course if you have any comments or would like to speak with a VMG consultant please don’t hesitate to contact us.