A glimmer of hope

Despite a slight easing of inflationary pressures and predicted geopolitical catastrophes failing yet to eventuate, we’re not out of the woods just yet, writes AICD chief economist Mark Thirlwell MAICD. 

Inflation, war in Ukraine, and China’s pandemic policies — as anticipated in February’s column, the issues that shaped much of 2022 have continued to dominate the economic landscape into 2023. However, there has been a shift in expectations. Last year ended on a grim note, with predictions of a global recession led by downturns in Europe and the US, compounded by significant uncertainty surrounding Beijing’s abrupt exit from its zero COVID-19 strategy. This year has brought tentative early optimism that perhaps things may turn out a bit better. For example, the updated IMF forecasts

in the January 2023 World Economic Outlook (WEO) saw the fund lift its estimate for global growth this year. Granted, the adjustment from the October 2022 WEO was only a modest 0.2 percentage point increase to 2.9 per cent. That would still represent a half percentage point drop in growth relative to 2022’s estimated 3.4 per cent outcome. Even so, it’s notable that the IMF felt an upgrade was appropriate.

Some of this shift in sentiment reflects the view that global inflation has peaked, with the WEO predicting that it will fall from an average of 8.8 per cent last year to 6.6 per cent this year. That’s partly due to commodity prices which, although still elevated relative to pre-pandemic levels, have eased significantly from last year’s highs. It also reflects a more general narrowing in global imbalances as demand growth has slowed, while falling transport costs and the easing of various supply chain bottlenecks have improved supply conditions. In the US, consumer price index (CPI) inflation had dropped to 6.5 per cent by December last year, down from June 2022’s four-decade high of 9.1 per cent. Across the OECD, CPI inflation had fallen to below double digits in December for the first time
since May 2022. Likewise, after peaking at more than 10 per cent in November 2022, Bloomberg’s daily global CPI inflation tracker had dropped to below nine per cent by early February 2023.

If sustained, falling inflation rates would allow central banks to temper their recent aggressive approach to monetary policy. Fewer additional rate hikes would mean less chance of a monetary policy-induced recession. Hence, the market focus on the US Federal Reserve’s decision to slow its pace of monetary tightening by delivering a 25bp rate increase at its meeting on 1 February this year — down from a 75bp hike last November and a 50bp increase in December.

Some geopolitical optimism

Sentiment has also evolved regarding Europe, which has proven to be more resilient than anticipated to spillovers from the war in Ukraine. Large falls in gas and electricity prices, an unusually mild winter, and large- scale government financial support have all buttressed European economies. That’s not to say that regional economic prospects suddenly look rosy. But the threat of a deep winter recession failed to manifest.

A third source of optimism relates to China, where forecasters anticipate stronger growth in 2023 after 2022’s sub-par three per cent.

The IMF, for example, thinks China’s economy will grow by more than five per cent this year, accounting for about a quarter of global growth. Initially, Beijing’s decision to reopen the economy against a backdrop of low population- wide immunity led to the feared surge in pandemic case numbers. But by late January, official data reported that COVID-19 hospital deaths had peaked earlier that month, before falling significantly, along with sharp falls in COVID-related infections and serious illnesses. International observers, including the World Health Organization, have expressed caution over these numbers — although less so over the underlying trend. Still, the current economic consensus is that as population mobility increases, pent-up consumption demand will deliver a Chinese version of the reopening rebound seen in other economies.

Meanwhile, on the home front

For the Australian economy, the year has seen a mixed start. The more optimistic global outlook saw the Australian dollar strengthen over most of January before weakening in early February. Higher commodity prices have further improved the budget finances, with Australia’s cumulative underlying cash balance to end December reporting a deficit of $14.7b, well down on the budget profile of a $26.2b shortfall. The unemployment rate also remains at a near multi- decade low of just 3.5 per cent, despite slowing employment growth.

Meanwhile house prices have continued to fall, with values nationwide down almost nine per cent from their pandemic peak — after having surged more than 28 per cent from their COVID-19 trough. Retail sales dropped by an unexpectedly large amount in December, suggesting cracks may be emerging in consumer spending as households curb discretionary purchases.

December quarter inflation was above expectations. At an annual rate of 7.8 per cent, the headline rate was the highest since 1990, beating the consensus forecast of 7.6 per cent, while the 6.9 per cent rate of underlying inflation was the highest in the history of that series. Hence, the Reserve Bank’s decision to increase the cash rate by another 25bp at its 7 February meeting was no surprise. Less expected was the hawkish tone of the accompanying statement by Governor Philip Lowe, which noted that the central bank “expects that further increases in interest rates will be needed over the months ahead”. “Increases” implied that more than one rate hike is yet to come, prompting markets to lift their estimate of the likely peak rate to about four per cent.

Where does that leave us? The global outlook looks better than it did a few months ago, but is subject to some of the same risks. While the recent trend in global inflation is encouraging, it’s still unclear how quickly central banks will be able to return inflation to target. That leaves the future path of monetary policy uncertain. Higher interest rates have already increased financial stress, and if markets are disappointed in their expectations regarding the limited scope of further monetary policy tightening, more volatility is likely.

Conditions, particularly in Europe, also remain hostage to further developments in the Russia-Ukraine war. China’s economic upturn is vulnerable to a COVID-19 relapse or a worsening in the already-imploding property market. Moreover, should it manifest, a strong China recovery is not without potential downsides, particularly if it stokes renewed international inflationary pressures.

It’s also a familiar picture at home. All else being equal, an improved global economic backdrop should support Australian growth prospects. But with the RBA signalling more cash rate increases ahead, the much-cited “narrow path” to a soft landing remains challenging.